Question

With inflation, what are the implications of using LIFO and FIFO inventory methods? How do they affect the cost of goods sold?

Short answer

Due to inflation in the market, the cost of goods sold decreases if the company use the FIFO inventory valuation method. It leads to an increase in the net income of the company. If the company uses the LIFO inventory valuation method, the cost of goods sold increases and leads to the decreases in the net income of the company.

Step-by-step solution

LIFO inventory valuation method

Under LIFO (last in first out) inventory valuation model, company sells or uses the newer unit first. In case of inflation, the last units purchased in the organization are more costly. Hence, the cost of goods sold increases and net income of the company decreases.

FIFO inventory valuation method

Under FIFO (First in first out) inventory valuation model, a company sells the older units first which are purchased by an organization during inflation at lower cost. Hence, the cost of goods sold decreases in this case and the net income of the company increases.