Multiple Choice
When using the FIFO (First-In, First-Out) method for inventory valuation, which of the following statements is correct?
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5. Inventory
Periodic Inventory - FIFO, LIFO, and Average Cost
Multiple Choice
In periods of rising prices, which of the following is an advantage of using the LIFO (Last-In, First-Out) inventory costing method?
A
It results in lower taxable income due to higher cost of goods sold.
B
It matches the oldest costs with current revenues.
C
It produces the highest net income among all inventory methods.
D
It results in inventory values that closely approximate current replacement costs.
Verified step by step guidance1
Understand the LIFO (Last-In, First-Out) inventory costing method: Under LIFO, the most recent inventory costs (the last items purchased) are matched with current revenues, meaning the newest costs are used to calculate the cost of goods sold (COGS).
Analyze the impact of rising prices: In periods of rising prices, the most recent inventory costs are higher than older costs. Since LIFO uses the most recent costs for COGS, the COGS will be higher under LIFO compared to other methods like FIFO (First-In, First-Out).
Consider the effect on taxable income: Higher COGS reduces gross profit, which in turn lowers taxable income. This is an advantage for companies as it reduces their tax liability during periods of rising prices.
Evaluate the other options: The statement 'It matches the oldest costs with current revenues' is incorrect because LIFO matches the newest costs with current revenues. The statement 'It produces the highest net income among all inventory methods' is also incorrect because higher COGS under LIFO results in lower net income. Lastly, 'It results in inventory values that closely approximate current replacement costs' is incorrect because LIFO leaves older, lower costs in inventory, which may not reflect current replacement costs.
Conclude that the correct answer is: 'It results in lower taxable income due to higher cost of goods sold,' as this is the primary advantage of using LIFO in periods of rising prices.
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