Inflation and Inventory Accounting Analysis

LIFO income statement in a rising price environment – LIFO method will lower reported margins.  Most recent goods are the most expensive and LIFO will calculate higher COGS and thus a lower gross profit.

LIFO balance sheet in a rising pricing environment – LIFO method lowers the value of inventory and thus the value of short term assets reported on the balance sheet.

FIFO income statement in a rising price environment – FIFO method will increase reported profit margins.  Oldest goods are the least expensive and FIFO will calculate lower COGS and thus a higher gross margin.

FIFO balance sheet in a rising pricing environment – FIFO method raises the value of inventory, as the least expensive items are taken off the balance sheet first

Deflation and Inventory Accounting Analysis

LIFO income statement in a falling price environment – LIFO method will raise reported margins.  Most recent goods are the least expensive and LIFO will calculate lower COGS and thus a higher gross margin.

LIFO balance sheet in a falling pricing environment – LIFO method raises the value of inventory because the cheapest items have been taken off the balance sheet first.

Example: If an analyst knows that a company employs LIFO and the prices of its goods have fallen due to weakening market demand, then the analyst may look to revise the balance sheet based on FIFO, as the real value of the company’s short-term assets is likely over-stated.