Rising Prices Inventory Method

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 LIFO (Last-In, First-Out) method.

The LIFO method assumes that the most recently acquired inventory items are sold first, while the older inventory items remain in stock. This means that the cost of goods sold (COGS) is calculated using the most recent (and usually higher) prices of inventory, which reduces the reported profits and, consequently, the ending inventory value.

To understand why LIFO produces the lowest value for ending inventory, let's consider an example:

Suppose a company purchases a particular product at different times during a period of rising prices:

• On January 1, the company purchases 100 units at $10 each, resulting in a total cost of $1,000.
• On February 1, the company purchases 200 units at $12 each, resulting in a total cost of $2,400.
• On March 1, the company purchases 150 units at $15 each, resulting in a total cost of $2,250.

Now, let's assume that the company sells 300 units during this period.

Using the LIFO method, the cost of goods sold (COGS) is calculated by assuming that the most recently acquired inventory is sold first. Therefore, the COGS would be:

• 150 units from the March 1 purchase at $15 each: 150 * $15 = $2,250
• 150 units from the February 1 purchase at $12 each: 150 * $12 = $1,800

Total COGS = $2,250 + $1,800 = $4,050

To calculate the ending inventory using LIFO, we assume that the oldest inventory items remain in stock. Therefore, the ending inventory would consist of the remaining 50 units from the January 1 purchase at $10 each: 50 * $10 = $500.

In this example, using the LIFO method, the ending inventory value is the lowest possible ($500) because it is based on the oldest (and usually lower-priced) inventory items.

Comparatively, the FIFO (First-In, First-Out) method assumes that the earliest acquired inventory items are sold first. This means that the COGS is calculated using the older (and usually lower) prices of inventory, resulting in higher profits and a higher value for ending inventory.

In summary, during a period of rising prices, the LIFO method gives the lowest possible value for ending inventory as it assigns the higher costs of recently acquired inventory to the COGS, reducing reported profits and leaving the older (and usually lower-priced) inventory items as the basis for the ending inventory valuation.