Question

What is the nature of FIFO phantom profits during periods of rising inventory purchase prices?

Answer 1

The terms phantom profits or deceptive profits are regularly utilized with regards to inventory (however can likewise relate to deterioration) amid times of increasing expenses. The measure of phantom or deceptive benefit is the distinction between the benefit revealed utilizing authentic expense—as required by generally accepted accounting principles (GAAP)— and the benefit that would have been accounted for if substitution cost had been utilized.

For instance, Company X moves items that are oil based. The recorded cost utilizing the first-in, first-out (FIFO) cost stream may have brought about $100 per unit showing up as the expense of merchandise sold on the ongoing pay explanation. Had the substitution cost of the item been utilized, the expense of merchandise sold may have been $145. Expecting the item was sold for $165, the fiscal summaries will report a gross benefit of $65 ($165 less $100). In the event that substitution cost would have been permitted and utilized, the gross benefit would be $20 (moving cost of $165 less the substitution cost of $145). The measure of phantom or fanciful benefit was $45 ($65 detailed less $20 estimated utilizing substitution cost). A market analyst would contend that you should initially supplant the thing before you can quantify the benefit. GAAP doesn't permit the utilization of substitution cost since that disregards the (chronicled) cost standard.

During periods of inflation the amount of phantom or illusory profits will be higher if the first-in, first-out (FIFO) cost flow assumption is used. The reason is that the inventory included in cost of goods sold is old inventory, which was purchased at lower price.