Comparison of cost flow assumptions for Chapter 8, Inventory

Criteria
FIFO
WAC
1) Quality of balance sheet for
High
Medium
valuation
FIFO provides high-quality information
(The balance sheet is most relevant about the value of inventory because
for valuation if the amount
it leaves the cost of the most recent
reported for an asset approximates purchases in ending inventory.
current value.)
2) Quality of income statement
Low
Medium
expense
The FIFO method includes costs from
(The income statement is most
beginning inventory in the calculation
relevant for evaluating
of COGS, so some of these costs are
performance if the basis for
outdated.
recognizing expenses matches the
basis for revenue recognition. Sales
revenue will generally reflect
market conditions in the reporting
period, so inventory costs that also
come from the reporting period are
the most relevant.)
3) Ease of income manipulation

Difficult
FIFO includes oldest costs first, so
ending inventory should reflect the
most recent cost information. So the
earnings manipulation through
reducing purchases is not possible in
FIFO.

LIFO
Low
LIFO values for ending inventory are low quality
because they consist of the oldest costs and so
deviate from current value.

High (if inventory level does not decrease)

LIFO cost of goods sold consists of costs from the
most recent purchases. So LIFO provides better
matching of COGS with revenue.
If the quantity sold exceeds purchases, then the LIFO
method will withdraw costs from older inventory
layers (purchases from prior years). These costs are
outdated. So this LIFO liquidation decreases quality
of costs of goods sold.

Difficult Easy
Same as Reduce purchases (in the case of retailer) or
FIFO
production (in the case of manufacturer) near yearend in order to make purchases fall below quantities
sold for the year. Then the LIFO method will use old
cost layers. If unit cost is increasing over time, the
LIFO liquidation will decrease costs and increase
earnings. If unit cost is declining over time, the LIFO
liquidation will increase costs and decrease earnings.