Impact of Inventory Method on COGS
The selection of an inventory method directly influences the calculation of the Cost of Goods Sold (COGS) and, consequently, financial statements. For example:
1. FIFO: During periods of rising prices, FIFO generally results in higher reported profits as it assumes that older, lower-cost inventory is sold first. This can positively impact a company’s tax liability and shareholder perceptions and vice-versa.
2. LIFO: In contrast, LIFO may result in lower reported profits during rising prices, but it can offer potential tax advantages by matching current, higher-priced inventory with current revenue. However, some jurisdictions may have restrictions on the use of LIFO.
3. Weighted Average Cost: This method provides a compromise, spreading the costs across all units, which can provide a more stable cost basis during fluctuating prices.
The choice of inventory method reflects management’s judgment on how to best represent the company’s financial performance and position.
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