3TI - Horngren'S Financial And Managerial Accounting

Question

Antelope Motors is considering which inventory costing method it should use. The business wants to maximize gross profits during a period of declining costs. Which inventory costing method should Antelope Motors select?

Step-by-Step Solution

Answer

LIFO method would yield the lowest cost and maximum gross profit under declining cost conditions

Step 1: Inventory costing methods

Inventory costing is a method of computing the cost of issued or sold inventory based on some cost flow assumption. There is major three cost flow assumption for this purpose. They are –

a) FIFO

b) LIFO

c) Average cost

 

Each assumption provides different values for COGS and ending inventory. These assumptions are also affected by the market conditions like rising or falling prices.

 

The FIFO assumption is based on the first-in-first-out order for applying cost to the issued inventory. LIFO takes the last-in-first order and the average method takes the average value for each sale under perpetual record. 

Step 2: Maximum gross profit and declining cost

Under declining cost conditions, the current cost would always be lower than the earlier cost. Thus, in order to maximize the gross profit, it is necessary that the cost of goods sold must be lowest. 

So as the cost is in a declining condition, the COGS would be lowest only if the issued inventory is valued at the current cost. 

 

This is possible only in the LIFO cost assumption.