Today’s Kaplan question of the day was about how LIFO has an income smoothing advantage over FIFO. Can someone please explain to me how this works?
In a rising price environment, using LIFO would produce smoother earnings because you’re utlizing a truer COGS for the time period.
Under FIFO, depending on how much inventory was built up, your COGS could be lower for quite sometime while prices are still rising. Thus you’re COGS is lagging true costs and as inventory is used you could experience greater volatiltiy in your COGS. That volatiltiy can lead to income being all over the place quarter to quarter.
LIFO = COGS based on recent prices does COGS reflects real market situation. Since thus recent COGS are faced to also actual priced Sales within same period, as above explained, it does impact on decrease of earnings volatilty.