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Impact of differing inventory valuation methods

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Explain the importance of understanding inventory valuation methods in determining the quality of the profit numbers.

If you compared two different companies that used two different valuation methods, how might the quality of the results differ? Also, comment on the difficulty in making comparisons between two firms that use different valuation methods.

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The solution describes the potential effects of differing inventory valuation methods.

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Inventory valuation methods can have a significant impact upon the profitability of a firm. As such, users of financial reports must understand that profits can be artificially inflated depending upon certain facts and be careful to make apples-to-apples comparisons between companies.

Imagine two retailers that sale widgets. Each company sales the same single model of widgets. It is the only item each sales. Both companies charge its customers $100 per widget. Company A uses FIFO (first in, first out) inventory valuation and Company B uses LIFO (last in, first out) inventory valuation. Both companies buy all their widgets from a ...

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