1. Inventory Accounting The effect a somewhat arbitrary choice of inventory accounting has on financial statements Presented March 23, 2001 by Paul Kadota for the Maxidigm Investment Club

2. Inventory Accounting 4th Unit $ 1st Unit $ 3rd Unit $ 2nd Unit $ Size of trapezoid represents cost of good produced

3. First In, First Out (FIFO) Out: oldest unit costs In: newest unit cost of production Newest Unit $ Oldest Unit $ Inventory Cost of Goods Sold

4. Last In, First Out (LIFO) Out: newest unit costs In: newest unit cost of production Newest Unit $ Oldest Unit $ Inventory Cost of Goods Sold

5. Comparisons using LIFO Reserve LIFO Reserve FIFO Inventory LIFO Inventory = -

6. LIFO to FIFO Balance Sheet n Add LIFO Reserve to LIFO Inventory n Inc. R.E. by (LIFO Reserve) * (1 - t) n Inc. defer’d tax by (LIFO Reserve) * t

7. Financial Ratios n Use LIFO for income-related n Use FIFO for balance sheet-related n Profit Margin: LIFO n Liquidity Ratios: FIFO n Turnover Ratios: ideally, LIFO COGS; FIFO Inventory

8. FIFO LIFO Comparison n Truer value of inventory n Unskewed Balance Sheet ratios n Can understate COGS and overstate income n Can result in higher taxes n Truer value of COGS n Unskewed Income Statement ratios n Can understate inventory and understate assets n Can result in lower taxes FIFOLIFO