if prices are decreasing, which inventory valuation method results in the highest cogs?
If prices are decreasing, which inventory valuation method results in the highest COGS?
Answer:
In a scenario where prices are decreasing, the inventory valuation method that results in the highest cost of goods sold (COGS) is the FIFO (First-In, First-Out) method.
The FIFO method assumes that the first items purchased or produced are the first ones to be sold. In a decreasing price environment, using FIFO will result in the oldest, and therefore, the most expensive inventory items being sold first. This leads to a higher COGS because the remaining inventory consists of the lower-cost items.
Let’s illustrate this with an example:
Suppose a company purchased 100 units of a product at different prices over time and sold 50 units during a period when prices were decreasing.
Using the FIFO method, the cost of goods sold (COGS) would be calculated by taking the cost of the oldest inventory first. This means that the COGS would be based on the higher prices paid for the initial purchases, resulting in a higher COGS value.
On the other hand, if we were to use other inventory valuation methods like LIFO (Last-In, First-Out) or Weighted Average Cost, the COGS would be calculated differently.
With LIFO, the most recently purchased or produced items are assumed to be sold first. In a decreasing price environment, this method would result in lower COGS because the most recent purchases would have lower costs.
The Weighted Average Cost method calculates the average cost of all inventory items and assigns that cost to both COGS and remaining inventory. In this method, the impact of decreasing prices on COGS might be slower compared to FIFO, as the average cost is affected by both older and newer inventory values.
Overall, while FIFO is more likely to result in the highest COGS when prices are decreasing, businesses may choose different inventory valuation methods based on their specific needs, industry standards, and regulations. It is important for companies to carefully consider the impact of inventory valuation on financial statements and make informed decisions to accurately reflect the cost of goods sold.