Question

Comparing inventory methods

Assume that a firm separately determined inventory under FIFO and LIFO and then compared the results.

1. In each of the below, select the less than, greater than, or equal sign for each comparison, assuming periods of rising prices.

a. FIFO ending inventory LIFO ending inventory

b. FIFO cost of goods sold LIFO cost of goods sold

c. FIFO net income LIFO net income

d.FIFO income tax LIFO income tax

2. Why would management prefer to use LIFO over FIFO in periods of rising prices?

In periods of rising prices, the net income shown on the company’s tax return would be lower under than under ; thus, there is a tax advantage of using .

Answer 1

1. a) FIFO ending inventory will be greater than LIFO ending inventory because costly items (during rising prices) that are purchased later will remain in the inventory in FIFO and the items (inexpensive) that were acquired first, will be sold first.

b) FIFO cost of the goods sold is less than LIFO cost of the goods sold because recently acquired items, that are being sold, are more expensive in LIFO.

c) FIFO net income is greater than LIFO net income because cost of the goods sold is less, so net income will be more.

d) FIFO income tax is greater than LIFO income tax because FIFO net income is higher than LIFO net income.

2. Because of some income tax benefits, the company chooses LIFO method over FIFO. In LIFO, the cost of the goods sold increases which reduces thye net income and ultimately it reduces the income tax liablility.