US GAAP requires inventory valuation on the basis of lower of cost or market (LCM). LCM is applied regardless of the inventory costing method used. Also, during rising or falling prices environment, FIFO inventory costing provides the best balance sheet information on the value of the inventory. Can someone please explain these statements further? Thanks!
FIFO (first in first out) means that the first inventory purchased is the first one that will be sold, meaning COGS will reflect the price of the first inventory your purchased. Therefore the remaining inventory will present the price that was last paid for your final inventory purchased. The price that you paid for the last inventory that you haven’t sold yet best reflects the market price of that product, regardless of whether you are in an inflationary or deflationary cycle. Here’s an example: You buy 2 similar products in this chronological order A for $20 B for $30 Assume you are using FIFO, you sell 1 product which is A. A is then reported as COGS on the IS, B remains in your inventory and is reported on the BS. B reflects current market price more than A if you were to repurchase the same product again because B was last purchased.
Statement #1: Upon purchase inventory will be recorded at cost. Regardless of what costing method is used the inventory is said to be at cost. At the end of the year/quarter a determination has to be made if the inventory as recorded in the books can be sold for at least the amount recorded in the books. If the FV > cost, leave the inventory at cost as it is lower. If the FV < cost, then the inventory has to be written down to the FV or market price as it is lower. Statement #2: Agree with sevago00. FIFO will always reflect the inventory that was purchased most recently and therefore is most likely closer to the market value of that inventory versus the other costing methods.
Perfect explanation. Thanks, guys!