Question

A company hired a new junior accountant to replace an accountant who recently retired. The reported balances for ending inventory and cost of merchandise sold were calculated by the previous accountant before he quit. The previous accountant assumed the FIFO method. Over the past year, the cost per unit of inventory purchased from the company's supplier decreased from $10 per unit to $9.00 per unit.

The new accountant decided to recalculate the balances for ending inventory and cost of merchandise sold. The new accountant's cost of ending inventory amount was higher and cost of merchandise sold was lower than the previous accountant's reported amounts. The new accountant assumed the LIFO method.

Assuming no calculation errors were made by either individual, what could have caused the recalculated amounts to be different from the original amounts?

How would you explain this to the company's chief accountant?

Answer 1

FIFO is a method that assumes that the goods bought in first are utilized first and LIFO assumes the opposite i.e. the last bought goods are utilized first.

In this case, the prices of the inventory has decreased from $10 to $9. This is a situation of decreasing prices. When prices decrease, under LIFO inventory method the net income reported will be higher due to cost of goods being lower. The cost of goods is lower in this case as the most recent price is assigned to the inventory in use. The cost of ending inventory Is higher in LIFO since the rates are assigned at the value that have been bought at higher prices.