Question

Which of the following statements regarding inventory accounting is true?

Multiple Choice

a. When physical inventory levels are decreasing and a company uses the absorption cost method, net income tends to increase.b.

b. Variable costing includes more than the variable costs of production in the valuation of inventory.

c. Analysts should be aware that when a company uses absorption costing, reported income tends to decrease as inventory absorbs more of the fixed costs.

d. When physical inventory levels are increasing and a company uses the absorption cost method, net income tends to increase.

Answer 1

The true statement regarding inventory accounting is:

c. Analysts should be aware that when a company uses absorption costing, reported income tends to decrease as inventory absorbs more of the fixed costs.

Step-by-step explanation:

In absorption costing, both variable and fixed costs are included in the cost of goods sold. When inventory levels increase, fixed costs are spread over a larger number of units, so the cost per unit decreases, and net income increases. Conversely, when inventory levels decrease, fixed costs are spread over fewer units, so the cost per unit increases, and net income decreases. Analysts should be aware of this relationship between inventory levels and net income when evaluating a company's financial statements.