Effects of Inventory Methods

During periods of rising prices, the LIFO method will show the lowest net income, FIFO the highest, and average cost, in between. The opposite effects occur in periods of falling prices. No generalization can be made regarding the specific identification method. The Internal Revenue Service requires that if LIFO is used for tax purposes, it must also be used for financial statement purposes, and that the lower-of-cost-or-market rule cannot be applied to the LIFO method. If the value of ending inventory is understated or overstated, a corresponding error - dollar for dollar - will be made in income before income taxes. Furthermore, because the ending inventory of one period is the beginning inventory of the next, the misstatement affects two accounting periods, although the effects are opposite.

• LIFO Liquidation