Question

If cost of acquiring inventory is rising. LIFO will result in which of the following compared to FIFO? (check all that apply)

1) Sales will be higher
2) cost of goods sold will be higher
3) gross profit will be lower
4) income tax expense will be lower

Answer 1

Using LIFO during periods of rising inventory costs leads to higher cost of goods sold and lower gross profits, which subsequently results in lower income tax expenses. Sales figures remain unaffected by the choice of inventory accounting method.

Step-by-step explanation:

When the cost of acquiring inventory is rising, the Last-In, First-Out (LIFO) inventory accounting method will have different financial outcomes compared to the First-In, First-Out (FIFO) method. Under LIFO, the most recently acquired or produced items, which typically have a higher cost due to inflation or rising prices, are sold first, leading to the following results:

• Sales will not be higher or lower as a direct result of inventory accounting methods.
• Cost of goods sold will be higher because the most recent and more expensive inventory is considered sold first.
• Gross profit will be lower due to the higher cost of goods sold, calculating lower earnings from sales.
• Income tax expense will be lower as profits are lower; less profit means less taxable income.

These effects make LIFO particularly useful in tax planning; by reporting lower profits, companies can defer a portion of their tax liability during periods of rising costs. However, it's important to note that while LIFO can affect financial statements, it does not impact the actual physical flow of inventory.