I’ve noticed many questions on the best estimate of COGS and inventory value based on LIFO and FIFO in either rising or falling price environments. Impact under rising prices seems easy to follow: - LIFO is the better approximation for COGS as it more closely matches current market. - FIFO is a better approximation for INV by the same logic. Is it correct to assume the same in a deflationary period? Regardless of price movements, would you want LIFO for COGS and FIFO for INV because they are closest to market price? Are there any specific things to watch out for regarding market price movements and the use of LIFO and FIFO aside from LIFO liquidations?
mcf, good questions. You’re correct that LIFO is always superior for the income statement and FIFO is always optimal for the balance sheet, regardless of the direction of price movements. As for situations that should catch your attention, other than LIFO liquidations, only one example comes to mind right now (maybe I need another coffee): I’d be curious about a company that changed its inventory accounting method from LIFO to FIFO, as it may be an attempt to inflate gross margins if inventory replacement costs have been rising, and perhaps the company has been under pressure to produce improved results. I vaguely recall that this type of change requires a convincing explanation and maybe even the restatement of prior results, but I’ll have to look this up again. Otherwise, from the perspective of exam preparation, it’s often easier begin learning the affects of LIFO and FIFO under the assumption of rising inventory replacement costs, but ensure you eventually understand that the impacts are reversed when replacement costs are declining over time (i.e. FIFO would produce lower margins and higher inventory balances than would LIFO, and vice versa). Hopefully others can chime in here and cover anything I’ve missed.