An analyst is evaluating a company after a period of time when prices have fallen. The company uses LIFO accounting. Which of the following is true? A The analyst must restate COGS because it is lower than what it would be under FIFO accounting B Income will be lower than it would be under FIFO accounting C Inventory need not be restated because the LIFO reserve will have decreased D COGS need not be restated because LIFO COGS is always an accurate measure of current cost as long as inventory quantity does not decline.
I’m on my last dose of RedBull. I am guessing on D?? My reasoning below… A. LIFO inventory used, Price-declining environment given, LIFO is still a true indicator of COGS (be it declining or be it rising). It correctly indicates the COGS close to it’s economic reality. B. Prices have fallen, COGS(LIFO) will be low --> NI(LIFO) will be high C. In period of falling prices, LIFO --> COGS low —> LIFO(I) high In period of falling prices, FIFO --> COGS high —> FIFO(I) low LIFO (reserve) = FIFO(I) - LIFO(I) LIFO (reserve) = low - high = spread decreases. But is the change in LIFO reserve, the economic representation of what really happened? - I feel - NO, as the reserve decreased due to deflation, so the Investories need to be restated. D. COGS(LIFO) is always an accurate measure of COGS (COGS-> low — in falling price env) (COGS->high — in rising prise env) … but in case of LIFO Liquidation, we are digging into the inventory layers that we already purchased (long time back) and selling them off, those are not true representation of COGS (older book-inventory might be too costly -> in case of continuous falling price env) Or (older book-inventory might be too cheap -> in case of continuous rising price env). So COGS does not work good for LIFO Liquidation and that’s what is meant by ‘inventory quantity does not decline’… So D seems correct Any thoughts??? - Dinesh S
it should be D
My guess is A because prices have fallen. Therefore, the COGS must be restated to reflect this change, and as a result “COGS is lower than if the company uses FIFO.” Now, LIFO COGS will be lower, and therefore the net income will be higher, and the opposite for FIFO.
the right answer is D. LIFO liquidation is the only time an analyst would have to make a special adjustment… when prices have been falling.
cpk123 beat me by a few hours. So frustrating
It’s D. So long as you’re not dealing with LIFO liquidation, then COGS need not be adjusted. If one is dealing with LIFO liquidation, then it should be excluded from earnings as they are non-operating in nature. A - LIFO reflects more accurately in COGS (from the income statement, which measures current activity) whereas FIFO does to inventory. B - Income would be higher under LIFO, not lower, as you’re expensing less costly inventory. C - In periods of falling prices or rising prices, one would be better off using replacement cost as opposed to historical cost. Hence, the need to always adjust inventory, irrespective of the LIFO effect. Also, refer to the following statement from page 315 of volume 3, 2008: “Note that only the adjustment of COGS to LIFO COGS is relevant. Adjustments of inventory balances to LIFO serve no purpose, as LIFO inventory costs are outdated and almost meaningless.” Also, from page 321, “The general guideline is to use LIFO numbers for ratio components that are income related and FIFO-based data for components that are balance sheet related.” Finally, directly referring to the topic of declining prices, page 330 states “The LIFO amounts on the balance sheet are not current and require adjustment, whereas the income statement amounts are current and do not need adjustment.”
Dinesh - Do you sleep?
apcarlso, sleep is a luxury for me now I am not yet confindent of so many things and the pressure for the exam is depriving me of my sleep. Dunno what’s gonna happen. - Dinesh S
Its D. You guys are so bingo.