In periods of rising costs, which one of the following inventory cash flow assumptions will result in higher cost of sales FIFO LIFO ?

In periods of rising costs, which one of the following inventory cash flow assumptions will result in higher cost of sales FIFO LIFO? 

ANSWER: LIFO

in period of rising cost , inventory must be consider as LIFO 

When prices are rising LIFO method yields a lower ending inventory, a higher cost of goods sold, a lower gross profit, and a lower taxable income.  The LIFO Method is preferred by many companies because it has the effect of reducing a company’s taxes and therefore increasing cash flow.

At the time of increaing cost Lifo methods will result in higher cost of sales and that is better for income tax purposes.

The answer is LIFO.

Let us understand the concept from the following hypothetical scenario. For simplicity we have neglected all other cost involved in manufacturing a product

 

Scenario

Consider an example where 1 unit of 'X' & 1 unit of 'Y' is required to produce the product A.

Assume that you have raw materials 'X' and 'Y' in your inevntory purchased at the following price.

'X' -$10 per unit

'Y' - $5 per unit

Now the prices have increased and you have made a new pruchase of raw materials at the following price.

'X' -$12 per unit

'Y' - $8 per unit

 

Now when you make a product 'A' and calculate the cost of manufacturing/sales the value will depend on the calculation method.

FIFO

In FIFO method, the value of raw materialis calculated as per the cost for which the older stock was purchased.

So cost of manufacturing = $10 + $5 = $15

LIFO

In LIFO method, the value of raw materialis calculated as per the cost for which the newer or most recent stock was purchased.

So cost of manufacturing = $12 + $8 = $20

 

Hence as you can see LIFO will result in higher cost of manufacturing/sale in periods of rising cost

lifo method is better,as it will show higher cost of goods sold.because last productions will sold out first hence we will charge customers as per the current production cost.

In period of rising costs  will result in higher cost of sales FIFO

This method assumes the first goods purchased are the first goods sold. In some companies, the first units in (bought) must be the first units out (sold) to avoid large losses from spoilage. In periods of rising prices (Inflation) FIFO has higher value of inventory and lower cost of goods sold; in periods of falling prices (deflation) it has lower value of inventory and higher cost of goods sold. Because a company using FIFO assumes the older units are sold first and the newer units are still on hand, the ending inventory consists of the most recent purchases Source: Boundless. “FIFO Method.” Boundless Accounting. 

Lifo 

A significant advantage of the LIFO method is its matching of current revenues with the most recent product costs. When prices are rising (which is most of the time), the most recent costs are the highest costs, resulting in higher cost of goods sold and lower net income. The lower net income means lower taxes.

FIFO METHOD USUALLY SHOW THE HIGHER PROFIT