Effect of Inflation and Deflation on Inventory (Accounting) - Explained
How do Inflation and Deflation affect the Financial Statements?
Written by J. Mance Gordon
Updated at April 7th, 2022
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Table of Contents
How Does Inflation and Deflation Affect Profitability of Product Sales?How is the Specific Identification Method Affected by Inflation? How is FIFO Inventory Method Affected by Inflation? How is LIFO Inventory Method Affected by Inflation? How is the Weighted Average Inventory Method Affected by Inflation?How Does Inflation and Deflation Affect Profitability of Product Sales?
In an inflationary period is when the value of a currency decreases and, thus, the price of goods rise. Deflation is the exact opposite. As such, these occurrences have an effect on the financial statements and how inventory is reported.
The effect of each method is discuss below.
How is the Specific Identification Method Affected by Inflation?
Specific notification will always yield the results that are dependent on which units are sold. As such, inflation and deflation are not going to change specific identification.
How is FIFO Inventory Method Affected by Inflation?
In an inflationary period, FIFO (or First-in, First Out) will result in higher immediate profit margins. The cost of older goods will be lower than the cost of newer goods. So, selling off older goods first will result in a higher profit margin. The exact opposite is true in a deflationary period.
How is LIFO Inventory Method Affected by Inflation?
In an inflationary period, LIFO (or Last-in, First Out) will result in a lower immediate profit margin. The cost of new goods is higher than that of older goods. So, selling off new goods first yields a lower margin that the LIFO or specific identification method. The exact opposite is the case in a deflationary period.
How is the Weighted Average Inventory Method Affected by Inflation?
During an inflationary period, the weighted average method will result in a profit yield somewhere in between LIFO and FIFO.
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