Question

Jim expects that the prices of the merchandises will dramatically decrease in the next future as a result of the Covid 19 crisis. Which method of valuation of the
inventory would you thus recommend to Jim? Explain your answer.

Answer 1

As the price of inventory is expected to decline in the future it is better to use First in First Out Method of valation of inventory as the newer inventory is less costly so better to replace new inventory with the old one. Moreover using FIFO will increase the Cost of Goods Sold with the old inventory in the stock which in turn will reduce the profits of the company and company has to pay less taxes so it advisable to Jim to use FIFO Method of Inventory Valuation.

Let us understand it will the help of example

Present Stock 100 Units of 50 each = 5,000

Expected Future Price of Merchandise = 40

Sale Price per Unit = 60

In this case using LIFO will reduce the Cost of Goods Sold and increase the profit whereas FIFO will increase the cost of goods Sold in comparison to LIFo and there will be less tax liability due to less profit also.