F3M3 - Inventory

Question 1

What happens to inventory values when a company changes from FIFO to LIFO in a period of rising prices?

Answer 1

Ending inventory and net income would decrease. The reason is because by switching to LIFO, the most recent inventory items are sold first.

This means that the older, and cheaper, inventory items are used to value the inventory thus decreasing the value of ending inventory.

The net income decreases as well because COGS will increase due to rising prices and because the newer inventory is being sold first.

Question 2

During periods of rising prices, when the FIFO inventory method is used, a perpetual inventory system results in an ending inventory cost that is:

Answer 2

The same as in a periodic inventory system.

Reason: FIFO always leaves the newest, higher-cost items in inventory, and both systems end up with the same value for those items.

With FIFO and rising prices, it doesn’t matter if you update inventory continuously or just at the end - the ending inventory cost will be the same.

Question 3

What is the COGS formula

Answer 3

COGS = Beginning inventory + purchases - ending inventory

Question 4

What is the ending inventory formula?

Answer 4

Ending inventory = Beginning inventory + purchases - COGS

*On the exam, I may have to find COGS as sales reduced to a cost basis i.e., (Sales - gross profit %). See F3M3 #31 for example.

*Beginning inventory + purchases = goods available for sale