Multiple Choice
Which of the following statements regarding the financial statement effects of inventory costing methods is FALSE?
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5. Inventory
Financial Statement Effects of Inventory Costing Methods
Multiple Choice
Which of the following statements best describes the effect of using the FIFO (First-In, First-Out) inventory costing method during a period of rising prices?
A
FIFO results in higher cost of goods sold and lower net income compared to LIFO.
B
FIFO and LIFO produce the same cost of goods sold and net income.
C
FIFO results in lower cost of goods sold and higher net income compared to LIFO.
D
FIFO is not permitted under U.S. GAAP.
Verified step by step guidance1
Understand the FIFO inventory costing method: FIFO assumes that the oldest inventory items (first-in) are sold first, meaning the cost of goods sold (COGS) reflects the cost of the earliest purchased inventory.
Consider the impact of rising prices: During a period of rising prices, the older inventory (purchased at lower costs) is used to calculate COGS under FIFO, resulting in a lower COGS compared to methods like LIFO (Last-In, First-Out).
Analyze the effect on net income: Since COGS is lower under FIFO during rising prices, the gross profit (Revenue - COGS) will be higher, leading to a higher net income compared to LIFO.
Evaluate compliance with accounting standards: FIFO is permitted under U.S. GAAP (Generally Accepted Accounting Principles), making it a valid inventory costing method.
Compare FIFO and LIFO outcomes: FIFO results in lower COGS and higher net income during rising prices, while LIFO results in higher COGS and lower net income. This difference is due to the order in which inventory costs are recognized.
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