Question

In: Accounting

Relationship between Inventory and COGS: Beginning Inventory + Purchases = Goods Available for Sale. Goods Available...

Relationship between Inventory and COGS:

Beginning Inventory + Purchases = Goods Available for Sale.

Goods Available for Sale = COGS + Ending Inventory

1. Which method yields higher net income? (Hint: Higher Ending Inventory means lower COGS. Lower COGS (COGS is an expense account) = Higher Net Income)

2. Which method would a business choose under the income statement approach?

3. Which method would a business choose under the Balance Sheet approach?

Solutions

Expert Solution

1)

  • LIFO method generates higher Net Income because the cost of goods is subject to inflation and LIFO considers the latest prices to compute the cost of goods sold.
  • Therefore, in this case, the cost of goods sold generates a higher value and ending inventory is valued at a lower value rather than FIFO.
  • To sum up: In the LIFO method, COGS is high, the Ending Inventory is low.

.

2)

  • Under the Income statement approach, it is better to value the cost of goods sold at a higher price and therefore lower Net income to evade Income taxes.
  • Therefore, it is better to opt for LIFO to value the cost of goods sold at a relatively lower price than FIFO.

.

3)

  • FIFO does better under the Balance Sheet approach because Any company would like to value its Ending inventory at the latest market prices.
  • FIFO does exactly the same. FIFO values the Ending inventory at the latest prices and cost fo goods sold at older prices.
  • Therefore, FIFO is a better option to value ending inventory rather than LIFO.

.

...

Feel free to ask any doubt.


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