Question

A firm has used LIFO for several years during which costs have trended higher. The effect on 2014 net income using LIFO, relative to FIFO, will be?

1) net income for 2014 will be greater under LIFO than FIFO.
2) net income for 2014 will be less under LIFO than FIFO.
3) net income for 2014 will be the same under LIFO as under FIFO.
4) can't tell from the information given.

Answer 1

In a period of rising costs, using LIFO would result in lower net income compared to FIFO.

Step-by-step explanation:

LIFO (Last-In, First-Out) and FIFO (First-In, First-Out) are methods used to account for the cost of inventory. In a period of rising costs, like the scenario presented, LIFO will result in a lower net income compared to FIFO. This is because LIFO assumes that the most recent purchases are the first ones sold, so the cost of goods sold is based on the higher recent prices.

As a result, there will be lower reported profits and taxes for the current period. To illustrate, let's say a firm purchased 10 widgets at $5 each at the beginning of the year, and then purchased an additional 10 widgets at $10 each later in the year.

If they sold 10 widgets, FIFO would assume the cost of goods sold is $5 each, resulting in a higher net income compared to LIFO which would assume the cost of goods sold is $10 each.