Final answer:
LIFO impacts financial statements by lowering ending inventory and net income, and increasing cost of goods sold, especially during inflationary periods. It results in older, typically cheaper inventory on the balance sheet, higher COGS, and lower NI before taxes.
Step-by-step explanation:
Impact of LIFO on Financial Statements
When a company uses the Last-In, First-Out (LIFO) inventory accounting method, it impacts various aspects of the financial statements, including ending inventory (E/I), cost of goods sold (COGS), and net income (NI). Under the LIFO method, it is assumed that the last items placed into inventory are the first ones sold. This accounting technique comes into play more significantly during periods of inflation.
Ending Inventory (E/I): Using LIFO, the older, and often lower-cost, inventory remains on the balance sheet. Therefore, during inflation, LIFO will report a lower E/I compared to other inventory methods like FIFO (First-In, First-Out).
Cost of Goods Sold (COGS): Since LIFO assumes the newest inventory is sold first, COGS is calculated using the prices of the more recently acquired inventory, which is generally higher during periods of inflation. This leads to a higher COGS under LIFO as compared to FIFO.
Net Income (NI): A higher COGS will result in a lower gross profit, assuming sales remain constant. Consequently, this diminishes the net income before taxes, and therefore, results in lower taxes. However, it also presents a lower NI on the income statement.
Furthermore, changes in COGS and NI will also affect other financial metrics and ratios that are critical for analysis by investors and creditors.