Multiple Choice
Which of the following best describes how the finance function ensures that the company’s financial goals are achieved in relation to inventory costing methods?
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5. Inventory
Financial Statement Effects of Inventory Costing Methods
Multiple Choice
Which of the following best describes the effect of using the LIFO inventory costing method during a period of rising prices on the company's financial statements?
A
Cost of goods sold increases, resulting in lower net income.
B
Net income is unaffected by the choice of inventory costing method.
C
Gross profit increases due to lower cost of goods sold.
D
Ending inventory is valued higher, resulting in higher total assets.
Verified step by step guidance1
Understand the concept of LIFO (Last-In, First-Out) inventory costing method: Under LIFO, the most recent inventory purchases (last-in) are assumed to be sold first, leaving older inventory (first-in) in ending inventory.
Analyze the impact of rising prices: During a period of rising prices, the cost of the most recent inventory purchases will be higher than the cost of older inventory. This means that under LIFO, the cost of goods sold (COGS) will reflect higher costs.
Consider the effect on net income: Higher COGS reduces gross profit, which in turn lowers net income. This is because net income is calculated as gross profit minus operating expenses and taxes.
Evaluate the impact on ending inventory: Since older inventory (purchased at lower prices) remains in ending inventory under LIFO, the ending inventory value will be lower compared to other methods like FIFO (First-In, First-Out).
Summarize the financial statement effects: Using LIFO during a period of rising prices results in higher COGS, lower gross profit, lower net income, and lower ending inventory value, which reduces total assets on the balance sheet.
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