During times of falling prices, pick the best representation for Income statement from an analyst’s perspective Economic, Accounting a) LIFO, LIFO b) FIFO, LIFO c) FIFO, FIFO d) LIFO, FIFO
I select answer d) LIFO reflect better economic value during falling prices, and FIFO show better both COGS and NI
a- lifo is better at representation in income statements and fifo on balance sheet
c. during falling prices, FIFO represents a better COGS, and a better Inventory.
pepp, How do you understand economic value here in this case? I read note book, whenever it mentions about economic value, it often says economic value of something. And in this case of inventory method, i think it refers to economic value of of COGS and Inventory. All this means economic value. But, what does it mean of “accounting”? Pls kindly make it clear. Thanks a lot!
I think Economic means higher net income and Accounting means truer reflection of reality (replacement cost). In this case, LIFO would be better for both and the answer would be A.
Economic reality is different from Accounting Reality.
I like making up controversial questions, no one has any idea how to answer them. we’ll wait till map comes online to clarify the concepts for all of us.
Pepp, i am trying to explain for you to check and for me to understand clearly. Map will come online soon and clarify it for all of us I think economic value mean true reflection of NI and also mean true reflection of COGS. And accounting value mean true reflection of Inventory value. So, my answer is still unchanged. It is d) Pls correct me if i misunderstood.
The same principles that work in an environment of rising prices (both with regards to economic and accounting whatever) should work in an environment of falling prices, but just in the opposite direction. I would use LIFO for valuation of BS because LIFO gives a better indication of inventory prices. I would use FIFO on IS, so that uncle Sam’s IRS would tax less, and money be put to real growth. That seems to be D.
Thanks map1 I have one question for your comment above. You said we should you FIFO on IS because of less tax bear. So, the reason for wrong indication of IS in period of falling price (and rising price if considering it) is income tax itself only? Or any other reason you haven’t mentioned yet? Thanks for yr explain!
I would say FIFO for the IS in an environment of falling prices gives a more conservative measure of COGS. Conservative information (one that reflects lower earnings on IS) is of better quality than aggresive information (one that reflects higher earnings). Now, as a plus to the previous, US GAAP requires that inventory be carried on BS at lower of cost or market (replacement cost). Which would be the cost of last unit bought.
A. LIFO always allocates current cost to Income statement and, thus, is better regardless of the price movements (LIFO values are closest to replacement costs). Milos
Economic you’d want to match the newest prices with what is going on in the marketplace so that would be lifo and for accounting you’d want LIFO for the income statement to get a current level of prices (decling) but for the balance sht you’d want FIFO to get a current level of inventories. Maybe i’m missunderstanding the Q though
what is the correct answer?
map1 Wrote: ------------------------------------------------------- > The same principles that work in an environment of > rising prices (both with regards to economic and > accounting whatever) should work in an environment > of falling prices, but just in the opposite > direction. > > I would use LIFO for valuation of BS because LIFO > gives a better indication of inventory prices. > > I would use FIFO on IS, so that uncle Sam’s IRS > would tax less, and money be put to real growth. > > That seems to be D. FIFO is always good on Inventory on Balance sheet, even during falling prices. (because prices are falling, you want to revalue your inventory lower by keeping the last items as part of inventory). However on the Income statement, during falling prices, COGS is severly underestimated, hence to be conservative use FIFO on IS as well. Lastly IRS mandates whatever you use for accounting purposes is what you use for TAX too.
Thank you pepp