if LIFO change to FIFO method, how it change to book value of company

Expert Solution

Solution:-

LIFO (Last in first out method) values inventory based on the assumption that the most recent inventory was used first and the older inventory is used later. Thus, the value of inventory left at the end of the year in balance sheet is calculated based on the purchase price paid for inventory that was purchased first.

On the contrary, if FIFO method is used for inventory valuation, it assumes that the inventory that was purchased earlier went into production first than the inventory purchased later, and therefore, the value of inventory left at the end of the year is calculated based on the purchase price of inventory that was purchased at the last.

The impact of change in method from LIFO to FIFO on the book value of company depends if there has been an inflation or deflation in the market prices of inventory.

If there is an ongoing inflation, it means that the purchase price paid for more recent inventory would be higher than the price paid for inventory bought before that. This means that changing method from LIFO to FIFO will in effect value inventory based on the higher prices paid for recent inventory, and thus increase the value of inventory. Increase in value of assets increases the book value of company and hence the book value will go up.

Similarly, if there is an ongoing deflation, the prices paid for recent inventory will be lower than the prices paid for older inventory. In such a situation, if method is changed from LIFO to FIFO, it will value inventory based on purchase prices of more recent inventory which have been lower due to inflation. This will reduce the value of inventory in balance sheet will will reduce the book value of the company.

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