Question

Assume that you are the president of your company and paid a year-end bonus according to the amount of net income earned during the year. When prices are rising, would you choose a FIFO or weighted average cost flow assumption? Explain, using an example to support your answer. Would your choice be the same if prices were falling?

Answer 1

If prices are rising, I would choose to use the FIFO (first-in, first-out) cost flow assumption. This is because under FIFO, the earliest inventory items purchased are assumed to be sold first, leaving the more recently purchased, and therefore higher-priced, items in inventory. As a result, the cost of goods sold (COGS) will be based on the lower, earlier purchase prices, resulting in higher net income and, therefore, a higher year-end bonus.

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