Question Of The Week

Recognition, Measurement, and Valuation – Assets

Bell Retail Company sells antique replica trunks to customers all over the world. Bell's inventory records show the following.

	Quantity (units)	Cost (each)
Beginning inventory	200	$1,055
Purchases:
June 3	170	1,062
September 18	190	1,070
December 10	160	1,076

Bell sells 470 units this year. Management is researching whether the company should use last in, first out (LIFO) or first in, first out (FIFO). If Bell's management wants to lower the company's income taxes, which inventory cost flow assumption should Bell select?

*Source: Retired ICMA CMA Exam Questions.

		A. FIFO, because the cost of goods sold will be $9,870 higher than LIFO.
		B. FIFO, because the operating income will be $840 lower than LIFO.
		C. LIFO, because the operating income will be $4,360 lower than FIFO.
		D. LIFO, because the cost of goods sold will be $5,250 higher than FIFO.

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Explanation

(Choice A) This answer is incorrect. When prices are increasing, cost of goods sold under FIFO is lower than cost of goods sold under LIFO because "older" goods are assumed to be sold first under FIFO.

(Choice B) This answer is incorrect. When prices are rising, operating income under FIFO is higher than operating income under LIFO.

(Choice C) In order to lower the company's income taxes, the company should use the method that would result in the highest cost of goods sold. LIFO operating income will be $4,360 lower than FIFO.

	LIFO cost of goods sold	FIFO cost of goods sold
Sales	(160 × $1,076) = $172,160	(200 × $1,055) = $211,000
	(190 × $1,070) = $203,300	(170 × $1,062) = $180,540
	(120 × $1,062) = $127,440	(100 × $1,070) = $107,000
	470 units $502,900	470 units $498,540

(Choice D) This answer is incorrect. Cost of goods sold under LIFO would be $5,250 higher than under FIFO only if all 470 units in ending inventory under LIFO is assumed to be valued at $1,055 per unit and all 470 units in ending inventory under FIFO is assumed to be valued at $1,076 per unit.

	LIFO cost of goods sold	FIFO cost of goods sold
Sales	(160 × $1,076) = $172,160	(200 × $1,055) = $211,000
	(190 × $1,070) = $203,300	(170 × $1,062) = $180,540
	(120 × $1,062) = $127,440	(100 × $1,070) = $107,000
	470 units $502,900	470 units $498,540

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