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In a period of rising costs, how does the recorded cost of goods sold (COGS) compare to the current COGS when using the first-in, first-out method?
The recorded COGS will be greater than the current COGS, so inventory will be overvalued.
The recorded COGS will be less than the current COGS, so inventory will be undervalued.
The recorded COGS will match the current COGS, so inventory will be fairly stated.
The recorded COGS will be an average of historical and current prices, so inventory value will be close but not exact.
The correct answer is: The recorded COGS will be less than the current COGS, so inventory will be undervalued.
When utilizing the first-in, first-out (FIFO) method in a period of rising costs, the recorded cost of goods sold (COGS) reflects the costs of the oldest inventory first, which were acquired at lower prices. As newer inventory comes in at higher costs during a period of inflation, the current COGS becomes higher because it reflects the costs of recently acquired inventory, which are more expensive. Therefore, since the recorded COGS consists of the costs of older, cheaper inventory, it will be less than the current COGS that accounts for the increased prices of more recent purchases. This discrepancy leads to the conclusion that in this scenario, inventory is undervalued on the books when looking at recorded COGS, as it does not reflect the current market conditions accurately due to these lower historical costs being recorded first. This understanding is critical for financial analysis and reporting, as it influences inventory valuation and net income.