For each of the following situations, indicate whether FIFO, LIFO, or weighted average applies.
a. In a period of rising prices, net income would be highest.
b. In a period of rising prices, cost of goods sold would be highest.
c. In a period or rising prices, ending inventory would be highest.
d. Ina period of falling prices, net income would be highest.
e. In a period of falling prices, the unit cost of goods would be the same for ending inventory and cost of goods sold.
a. In a period of rising prices, FIFO (First-In, First-Out) applies. Under the FIFO method, the oldest or earliest acquired units are assumed to be sold first. Therefore, the cost of goods sold would include the older, lower-priced units, and the net income would be highest because the cost of goods sold would be lower.
b. In a period of rising prices, LIFO (Last-In, First-Out) applies. Under the LIFO method, the most recently acquired units are assumed to be sold first. Therefore, the cost of goods sold would include the newer, higher-priced units, and the cost of goods sold would be highest.
c. In a period of rising prices, weighted average applies. The weighted average method calculates the average cost of all units in inventory, regardless of when they were acquired. Therefore, the ending inventory would be highest as it includes all units at their average cost.
d. In a period of falling prices, LIFO applies. Under the LIFO method, the most recently acquired units are assumed to be sold first. Therefore, the cost of goods sold would include the older, lower-priced units, resulting in a higher net income.
e. In a period of falling prices, weighted average applies. The weighted average method calculates the average cost of all units in inventory, regardless of when they were acquired. Therefore, the unit cost of goods would be the same for ending inventory and cost of goods sold.
To determine whether FIFO (First-In, First-Out), LIFO (Last-In, First-Out), or weighted average method applies to each situation, let's break them down one by one:
a. In a period of rising prices, net income would be highest:
- FIFO: The first inventory items purchased (at lower prices) are assumed to be sold first, resulting in lower cost of goods sold and higher net income.
- LIFO: The last inventory items purchased (at higher prices) are assumed to be sold first, resulting in higher cost of goods sold and lower net income.
- Weighted average: The average cost of all inventory items is calculated and applied to both cost of goods sold and ending inventory, resulting in net income neither being the highest nor the lowest.
b. In a period of rising prices, cost of goods sold would be highest:
- FIFO: The first inventory items purchased (at lower prices) are assumed to be sold first, resulting in lower cost of goods sold.
- LIFO: The last inventory items purchased (at higher prices) are assumed to be sold first, resulting in higher cost of goods sold.
- Weighted average: The average cost of all inventory items is calculated and applied to cost of goods sold.
c. In a period of rising prices, ending inventory would be highest:
- FIFO: The most recent inventory items purchased (at higher prices) remain in the ending inventory, resulting in higher ending inventory.
- LIFO: The earliest inventory items purchased (at lower prices) remain in the ending inventory, resulting in lower ending inventory.
- Weighted average: The average cost of all inventory items is applied to the ending inventory.
d. In a period of falling prices, net income would be highest:
- FIFO: The oldest inventory items (at lower prices) are assumed to be sold first, resulting in lower cost of goods sold and higher net income.
- LIFO: The most recent inventory items (at higher prices) are assumed to be sold first, resulting in higher cost of goods sold and lower net income.
- Weighted average: The average cost of all inventory items is applied to both cost of goods sold and ending inventory, resulting in net income neither being the highest nor the lowest.
e. In a period of falling prices, the unit cost of goods would be the same for ending inventory and cost of goods sold:
- FIFO: The unit cost of ending inventory would be higher than the unit cost of goods sold since the older, lower-priced inventory items remain in ending inventory.
- LIFO: The unit cost of goods sold would be higher than the unit cost of ending inventory since the most recent, higher-priced inventory items are assumed to be sold first.
- Weighted average: The unit cost of goods sold and ending inventory would be the same since the average cost of all inventory items is applied to both.
In summary:
a. FIFO would result in the highest net income.
b. LIFO would result in the highest cost of goods sold.
c. FIFO would result in the highest ending inventory.
d. FIFO would result in the highest net income.
e. Weighted average would result in the same unit cost for both ending inventory and cost of goods sold.