Inventory Method and Effect on Income Statement

Different inventory valuation methods can have significant effects on net income as reported in financial statements and on income tax returns as well.

Valuing a company report inventory using LIFO inventory method require to adjust cost of goods sold and balance sheet to a FIFO basis. We make this adjustment by adding the LIFO reserve to the company’s equity (net of taxes) and subtracting the change in the LIFO reserve from year-to-year to the company’s cost of goods sold, prior to capitalizing our indication of the company’s earning power.

	FIFO	LIFO	Specific Identification	Moving Average
Sales	$5,010	$5,010	$5,010	$5,010
Cost of Good Sold	$3,738	$3,560	$3,738	$3,762
Gross Profit	$1,272	$1,450	$1,272	$1,248
Operating Expenses	$450	$450	$450	$450
Income Before Taxes	$822	$1,000	$822	$798
Income Tax Expense (30%)	$247	$300	$247	$239
Net Income	$575	$700	$575	$559

 

Inventory Turnover Rate

The inventory turnover rate formula is listed below, it is equal to cost of goods sold over average inventory. Inventory turnover rate provide information to financial statements users to evaluating the liquidity of a company's inventory. The inventory turnover also serve as an indicator to products that is not selling well and may resulted in obsolete.

Inventory Turnover ratio = COGS / Average Inventory

Average Inventory = (Beginning Balance + End Balance) /2

Days in Inventory = 365 / Inventory Turnover ratio.