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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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FIFO and LIFO

A company may compute inventory under one of various cost flow assumptions. Among these assumptions are first-in, first-out (FIFO) and last-in, first-out (LIFO). In the past, some companies have changed from FIFO to LIFO for computing portions or all of their inventory.

Required:

  1. 1. Ignoring income tax, explain what effects a change from FIFO to LIFO has on a company’s net earnings and working capital.
  2. 2. Explain the difference between the FIFO assumption of earnings and operating cycle and the LIFO assumption of earnings and operating cycle.

1.

To determine

Ascertain the impact on the net earnings and working capital of a company due to a change from FIFO to LIFO.

Explanation

First-in-First-Out (FIFO): In this method, items purchased initially are sold first. So, the value of the ending inventory consists the recent cost for the remaining unsold items.

Last-in-First-Out (LIFO): In this method, items purchased recently are sold first. So, the value of the ending inventory consists the initial cost for the remaining unsold items.

The following impact is seen on shifting from the FIFO to LIFO method:

  • During constant price and constant inventory:

    In the period of no fluctuations in the prices and the inventory being used remains the same, there is no impact on the net earnings and working capital of a company due to a change from FIFO to LIFO.

  • During rising price and constant inventory:

    In the period of rising prices and the inventory being used remaining the same, the net earnings and working capital of a company, tend to reduce due to a change from FIFO to LIFO...

2.

To determine

Differentiate the assumption of earnings and operating cycle as per FIFO and LIFO.

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