Ending inventory is made up of the oldest purchases when a company uses
A) First-in, First-out (FIFO)
B) Last-in, First-out (LIFO)
C) Average cost
D) Retail method
The Last In, First Out (LIFO) method is used to determine which items are sold first based on when they were produced. According to LIFO, the cost of the recently purchased (or produced) products will be reported as cost of goods sold (COGS), so older products will appear as inventory when their cost is lower.
A company’s inventory costs can be calculated in two ways: first in, first out (FIFO), where the oldest inventory items are recorded as sold first, and average cost, which calculates the COGS and ending inventory by averaging the weighted average of all units sold during the accounting period.
There are three types of inventory-costing methods permitted by generally accepted accounting principles (GAAP) to be used in the United States, but last in, first out (LIFO) is only used there. The LIFO method is prohibited by the International Financial Reporting Standards (IFRS). Inventory valuations are used by retailers and auto dealerships with large inventories because they can take advantage of lower taxes (when prices are rising) and higher cash flows. The majority of U.S. companies use FIFO, however, since using LIFO for taxes means using LIFO when a company reports its financial results. This lowers profits and, subsequently, earnings per share.