Final answer:
Using the FIFO inventory costing method can help minimize income tax expenses during a period of declining inventory costs.
Step-by-step explanation:
When inventory costs are declining, using the FIFO (First-In-First-Out) method can help a company minimize its income tax expenses.
With the FIFO method, the assumption is that the oldest inventory items are sold first, and the cost of goods sold (COGS) is based on the cost of those older items. As inventory costs decline, using the FIFO method ensures that the lower-cost items are matched with sales, resulting in a lower COGS and, consequently, lower taxable income.
In contrast, the LIFO (Last-In-First-Out) method assumes that the newest inventory items are sold first. As inventory costs decline, using LIFO can lead to higher COGS and taxable income because the most recent, potentially higher-cost items are matched with sales.
During a period of declining inventory costs, a company that intends to minimize its income tax expenses should use the Last-In-First-Out (LIFO) inventory costing method. Under LIFO, the most recently acquired inventory is considered sold first, which means the higher cost of inventory purchased at earlier date remains on balance sheet while lower cost inventory is expensed. In a scenario with declining costs, this results in a lower ending inventory value and higher cost of goods sold (COGS), which consequently reduces the taxable income due to the rising expense recognition.