The correct option is B. First-In, First-Out (FIFO). Explanation of the Correct Answer First-In, First-Out (FIFO) is an inventory valuation method that assumes that the oldest inventory items are sold first. This means that when a company sells its products, it is selling the items that were purchased or produced first. How FIFO Affects Cost of Goods Sold (COGS) and Ending Inventory

1. Cost of Goods Sold (COGS): Under FIFO, the cost of the oldest inventory is used to calculate COGS. In times of rising prices, the older inventory costs are typically lower than the newer inventory costs. Therefore, when calculating COGS, FIFO results in a lower expense because it reflects the cheaper costs of older inventory. This leads to higher reported profits in the income statement.
2. Ending Inventory Valuation: Since FIFO assumes that the oldest items are sold first, the ending inventory consists of the most recently purchased items, which are at higher costs during periods of inflation. This results in a higher ending inventory value on the balance sheet.

Example Calculation Let’s say a company has the following inventory purchases:

• 100 units at $10 each (oldest)
• 100 units at $12 each (newer)
• 100 units at $15 each (newest)

If the company sells 150 units, under FIFO, the COGS would be calculated as follows:

• 100 units from the first batch at $10 = $1,000
• 50 units from the second batch at $12 = $600

Total COGS = $1,000 + $600 = $1,600 The ending inventory would consist of:

• 50 units from the second batch at $12 = $600
• 100 units from the third batch at $15 = $1,500

Total Ending Inventory = $600 + $1,500 = $2,100 Why the Other Options Are Incorrect A. Last-In, First-Out (LIFO): This method assumes that the most recently purchased inventory items are sold first. In times of rising prices, LIFO results in higher COGS because it uses the higher costs of the latest inventory, leading to lower profits and lower ending inventory values. This is the opposite of FIFO. C. Weighted Average Cost: This method averages the cost of all inventory items available for sale during the period and applies that average cost to both COGS and ending inventory. It does not specifically assume that the oldest or newest items are sold first, making it less sensitive to price changes compared to FIFO. D. Specific Identification: This method tracks the actual cost of each specific item sold. It is typically used for unique or high-value items (like cars or real estate) rather than for large quantities of similar items. It does not assume any order of sale and is not affected by rising prices in the same way FIFO is. Common Pitfalls

• Confusing FIFO with LIFO: Students often mix up FIFO and LIFO. Remember, FIFO sells the oldest items first, while LIFO sells the newest items first.
• Ignoring the impact of inflation: When considering how inventory methods affect financial statements, it’s crucial to understand how rising prices influence COGS and ending inventory differently under FIFO and LIFO.

Revision Summary

• FIFO assumes the oldest inventory is sold first, leading to lower COGS and higher ending inventory during rising prices.
• COGS under FIFO reflects older, cheaper costs, resulting in higher profits.
• LIFO, Weighted Average Cost, and Specific Identification are alternative methods with different implications for financial reporting.
• Understanding the impact of inventory valuation methods is essential for accurate financial analysis and decision-making.