Which valuation method tends to underestimate inventory values?

The LIFO (Last In, First Out) valuation method tends to underestimate inventory values, particularly in times of rising prices. This is because LIFO assumes that the most recently purchased items are the first to be sold. When costs are increasing, the more expensive inventory is accounted for as sold first, resulting in lower ending inventory values on the balance sheet. Consequently, this method can impact both the cost of goods sold (COGS) and the value of remaining inventory, typically showing lower profits due to higher expenses reflected in COGS.

In contrast, FIFO (First In, First Out) usually leads to a higher inventory valuation under the same circumstances since it sells the older, less expensive inventory first. Actual purchase price would reflect the actual costs incurred for inventory, leading to accurate values rather than underestimations. The weighted average purchase price method averages the cost of inventory, providing a moderate valuation that does not lean heavily towards underestimating or overestimating the inventory value. Thus, LIFO is distinct in its tendency to portray reduced inventory values in an inflationary environment.