Question

1. A firm is assumed to use perpetual system which separately determined inventory under FIFO and LIFO and then compare the results.

i) In each space below, place the correct sign (< / > / =) for each comparison by assuming periods of rising prices.

a. FIFO supplies                      ____________ LIFO supplies

b. FIFO cost of sales              ____________ LIFO cost of sales

c. FIFO net profit                    ____________ LIFO net profit

d. FIFO taxable income        ____________ LIFO taxable income

ii) Why the use of LIFO is more preferable by a management compared to FIFO in period of rising prices?

(5)

(Total: 15 marks)

Answer 1

i) In a situation of rising prices the cost of inventory latest purchased would be higher as compared to the cost of inventory purchased earlier. As a result, the cost supplies under FIFO method will be lower as compared to the cost of supplies under LIFO method. Hence,

a. FIFO supplies = LIFO supplies

b. FIFO cost of sales < LIFO cost of sales

c. FIFO net profit > LIFO net profit

d. FIFO taxable income > LIFO taxable income

ii) In a period of rising prices, the cost of inventory latest purchased is higher than the cost of inventory purchased earlier. In LIFO method, the units which are acquired last, are first issued. This results in higher cost of goods sold as compared to the cost under FIFO method. Higher cost of goods sold results in lower gross profits, net profits, taxable income which ultimately results in lower income tax liability and payments.

Therefore, the use of LIFO is more preferable by a management compared to FIFO in a period of rising prices.