When prices are rising, which method of inventory, if any, will result in the lowest relative net cash outflow (including the effects of taxes, if any) ?

Question

Business

Alondra Livingston

13 August, 14:52

When prices are rising, which method of inventory, if any, will result in the lowest relative net cash outflow (including the effects of taxes, if any) ?

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Answers (1)

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Brett Park · Answer 1

Last in First Out (LIFO)

Explanation:

When prices are rising, the Last in First Out (LIFO) inventory valuation method will ensure that inventory is valued first at higher costs leading to the computation of the highest Cost of Goods Sold (COGS) based on rising prices for a period. This will in turn reduce the net income for the period. And the lower the income, the lower the tax, well, all things being equal.

First In First Out (FIFO) is not ideal because lower prices will be used to valuate Cost of Goods Sold and when this is compared with sales, the taxable income for the period will be high leading to higher taxes, if any.

For instance, LIFO; 1st Dec, Purchases - $50, 3rd Dec, Purchases - $65 and 6th Dec, Purchases - $70 dollars. To arrive at COGS, the value of the last purchase of $70 will be used leading to a higher COGS as compared to using the first purchase of $50.