Cost flow assumptions
| Method | Effect in rising prices |
|---|---|
| FIFO | Lower COGS, higher ending inventory, higher net income |
| LIFO | Higher COGS, lower ending inventory, lower net income (and lower tax) |
| Weighted average | Falls between FIFO and LIFO |
IMPORTANT: LIFO is permitted under US GAAP but not under IFRS. A company using LIFO for tax purposes in the US must also use it for financial reporting (the "LIFO conformity rule") — this is a US-specific, exam-favorite fact.
Subsequent measurement
Under US GAAP:
- FIFO or weighted average: measured at the lower of cost and net realizable value (LCNRV). NRV = estimated selling price − reasonably predictable costs of completion and disposal.
- LIFO or retail method: measured at the lower of cost or market (LCM), where "market" is replacement cost, bounded by a ceiling (NRV) and floor (NRV − normal profit margin).
EXAMPLE: Inventory costs $80. Selling price is $100, with $15 of disposal costs (NRV = $85) and a normal profit margin of $10 (floor = $75). If replacement cost is $70, "market" is bounded between $75 and $85, so market = $75. Lower of cost ($80) or market ($75) = $75.
Periodic vs. perpetual
Perpetual systems update inventory and COGS with every transaction; periodic systems calculate COGS only at period-end via a physical count (Beginning inventory + Purchases − Ending inventory = COGS). Under FIFO, periodic and perpetual give the same answer; under LIFO and weighted average, they can differ.
EXAM TIP: Freight-in is added to inventory cost; freight-out (delivering to customers) is a selling expense — don't capitalize it.