In its first month of operations, McLanie Company made three purchases of merchandise in the following sequence: (1) 300 units at $6, (2) 400 units at $8, and (3) 500 units at $9. Assuming there are 200 units on hand at the end of the period, compute the cost of the ending inventory under (a) the FIFO method and (b) the LIFO method. McLanie uses a periodic inventory system.
The correct answer and explanation is:
To compute the ending inventory under the FIFO (First-In, First-Out) and LIFO (Last-In, First-Out) methods, we first calculate the cost of the 200 units remaining at the end of the period, based on the order of purchases.
Purchases Summary:
- 300 units @ $6 = $1,800
- 400 units @ $8 = $3,200
- 500 units @ $9 = $4,500
Total units purchased: 1,200 units
Ending inventory: 200 units
(a) FIFO Method:
Under FIFO, the oldest inventory is sold first, so the remaining 200 units are from the most recent purchase(s).
- The 200 units left come from the 500 units purchased at $9.
200 units × $9 = $1,800
Ending Inventory under FIFO = $1,800
(b) LIFO Method:
Under LIFO, the newest inventory is sold first, so the remaining 200 units are from the oldest purchase(s).
- The 200 units left come from the 300 units purchased at $6.
200 units × $6 = $1,200
Ending Inventory under LIFO = $1,200
Explanation:
The FIFO method assumes that inventory purchased first is sold first, leaving the most recent purchases in inventory. As a result, the ending inventory reflects the most recent (higher) costs, which is why the cost is $1,800 under FIFO.
Conversely, the LIFO method assumes that inventory purchased last is sold first, leaving the oldest (lower) costs in inventory. This results in an ending inventory of $1,200 under LIFO.
These methods affect the valuation of inventory and cost of goods sold (COGS) differently, which can impact reported profitability and tax obligations. FIFO often results in higher ending inventory values in periods of rising prices, while LIFO reduces taxable income by increasing COGS.