[gemini8706]

The question given to me are is as below

"In times of rising prices would you reccomend fifo or lifo method?Why"

The answer I have is lifo will be used as it will tend to give a more realistic measure of profit but results in an outdated stock valuation being disclosed in the balance sheet.

Is there any other reasons as to why lifo is used?

Thank u

[morgaine300]

First, the real answer to this is that it's a matter of opinion. The reason we have more than one method is because there are advantages and disadvantages to each method, and people don't even agree on that. So there is no "real" answer about which one you "should" use.

Your answer that it will tend to give a more realistic measure of profit first of all is not related to whether prices are rising or falling. It's also an opinion that it's "more realistic." That's OK that that's your opinion, as long as you give sound reasoning for it. My point is that your answer doesn't fit in with the question about during rising prices. Your reasoning would also count if it was declining prices. It's based on the concept of replacement value, so it's more in keeping with current replacement value, regardless of what prices are doing.

I think they're trying to stress the idea that it's rising prices. The "usual correct" answer to this in textbooks is LIFO because it results in lower taxes. But that's kind of a chancy thing for me to say because your textbook may not fit the norm. That's just what I usually see in textbooks -- they stress the concept that LIFO during rising prices results in lower taxes.

The problem with that answer is that it's not all there is to it. In rising prices, LIFO will increase cost of goods sold, which being an expense, lowers operating income. Which in turn lowers taxes. But it also looks worse that operating income is lower, huh? And a lower net income lowers equity. And it further lowers the ending inventory value (because the lower-priced 'first in' ones were left in inventory), which lowers asset value.

You may want to scan the chapter and see if they mention or stress the idea of it causing lower taxes. If so, that's the answer they probably want. If not, because the question is saying during rising prices, I think I'd concentrate more on the effect of the rising prices, as opposed to just using more current prices. And your statement about the stock is incorrect. Net income is closed out to retained earnings and does not affect the stock at all. So I'm not sure what you mean by an outdated stock valuation. The stock stays the same on the books and has nothing to do with inventory valuation.