Final answer:
The inventory cost flow assumption affects the cost of goods sold on the income statement and inventory on the balance sheet, with the specific impact depending on the chosen inventory costing method (e.g., FIFO or LIFO). The correct answer to the question presented is option 3) income statement; balance sheet.
Step-by-step explanation:
The assumption that a company makes about its inventory cost flow can affect cost of goods sold on its income statement and inventory on its balance sheet. Therefore, the correct answer to the student's query is option 3) income statement; balance sheet. When a company chooses an inventory costing method, such as FIFO (First-In, First-Out) or LIFO (Last-In, First-Out), it impacts the reported cost of goods sold and the value of inventory at the end of the period. A change in inventory value affects the balance sheet, while any change in the cost of goods sold will affect the profitability as shown on the income statement.
For instance, if a company chooses LIFO during a period of rising prices, the most recent—and higher-cost—inventory is considered sold first, leading to higher cost of goods sold and lower inventory values compare to FIFO, where older and generally lower-cost inventory is considered sold first. This difference can have a significant effect on the company's reported net income and taxes due to variances in cost of goods sold as well as an impact on the company's assets as reported on the balance sheet due to changes in inventory valuation.