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 higher new inventory costs in an inflationary climate, the current COGS under LIFO would be higher. The business would report lower earnings or net income due to the period.

Step-by-step solution

Implication of FIFO

FIFO (or First-in, First Out) will give higher profit margins in an inflationary period. The cost of newer goods will be higher than that of older goods—that's why selling off older low-cost goods first will give a higher profit.

Implication of LIFO

The last-in, first-out (LIFO) method of tax accounting for inventories is advantageous in an inflationary economy because it enables a taxpayer to compute a higher cost of goods sold deduction by using an inflated current cost instead of a lower cost of goods sold deduction based on the lower historical cost