Final answer:
During a deflationary period, the LIFO inventory system often leads to the highest net income, because it aligns with the decrease in prices, thereby reducing taxable income and increasing net income.
Step-by-step explanation:
In a deflationary period, where costs are lowering, the inventory system that typically results in the highest net income is Last-In, First-Out (LIFO). This is because during deflation, prices of goods tend to decrease, and the LIFO method assumes that the most recently acquired items (which are presumed to be the cheaper ones during deflation) are sold first. This results in a higher cost of goods sold (as it reflects the more expensive items purchased before deflation), thus reducing the taxable income and increasing net income.
Conversely, in an inflationary period, the First-In, First-Out (FIFO) method would typically result in a higher net income because it assumes the oldest, cheaper items are sold first, resulting in a lower cost of goods sold and higher profits when prices are rising.
It is important to note that the choice of inventory accounting can have significant tax implications and can affect the reported profit of a business. Therefore, in periods of changing prices, businesses may opt for the inventory system that provides a tax or cash flow advantage.