In a period of rising prices, the inventory method that gives the lowest possible value for ending inventory is:
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A. B. C. D.B
The ending inventory under LIFO is priced at the earliest, and thus the lowest prices (in a period of rising prices) than any of the other methods.
In a period of rising prices, the inventory method that gives the lowest possible value for ending inventory is the Last-In, First-Out (LIFO) method. Therefore, the correct answer is B. LIFO.
Now let's delve into a detailed explanation:
Inventory methods determine how the cost of goods sold (COGS) and the value of ending inventory are calculated. The choice of inventory method can have a significant impact on financial statements, particularly in periods of changing prices.
Weighted Average Method: The weighted average method calculates the average cost of all units available for sale during the period and applies this average cost to both COGS and ending inventory. It assumes that each unit has the same cost, regardless of when it was purchased. Therefore, during a period of rising prices, the weighted average method will yield a COGS and ending inventory value that falls between the values calculated under LIFO and FIFO.
LIFO Method: The Last-In, First-Out (LIFO) method assumes that the most recent inventory purchases are sold first. Therefore, the cost of the most recent purchases is matched against revenue, resulting in the highest possible cost of goods sold (COGS). The older, lower-cost inventory is assumed to remain in ending inventory, resulting in a lower value for ending inventory. In periods of rising prices, this method gives the lowest possible value for ending inventory because the older, lower-cost inventory is valued on the balance sheet.
FIFO Method: The First-In, First-Out (FIFO) method assumes that the oldest inventory purchases are sold first. This results in matching the older, lower-cost inventory against revenue, leading to a lower COGS. The most recent purchases are assumed to remain in ending inventory, resulting in a higher value for ending inventory. In periods of rising prices, FIFO will give the highest possible value for ending inventory because the more recent, higher-cost inventory is valued on the balance sheet.
Gross Profit Method: The gross profit method is not an inventory valuation method but rather an estimation technique. It uses the gross profit percentage to estimate the value of ending inventory based on the available information. This method is used when the detailed records of inventory are lost or when there are significant inventory losses due to theft, damage, or other reasons. The gross profit method is not specifically related to any particular inventory valuation method, and its use does not necessarily yield the lowest value for ending inventory.
In conclusion, during a period of rising prices, the LIFO inventory method gives the lowest possible value for ending inventory because it assumes that the older, lower-cost inventory remains in ending inventory, while the more recent, higher-cost inventory is matched against revenue as COGS.