Business Degree Certification Practice Test

In a period of rising prices, which inventory valuation method usually results in the lowest ending inventory value and net income?

1. First in, first out (FIFO)

2. Last in, first out (LIFO)

3. Weighted average

4. Standard cost

The correct answer is: Last in, first out (LIFO)

In a period of rising prices, the Last in, First out (LIFO) inventory valuation method typically results in the lowest ending inventory value and net income. This is due to the way LIFO operates; it assumes that the most recently acquired items are sold first. Therefore, when prices are increasing, the cost of goods sold (COGS) will reflect these higher prices, leading to a higher expense and consequently a lower net income. As a result of this increased COGS under LIFO, the value of the remaining inventory on the balance sheet is based on older, lower-cost items. This leads to a lower ending inventory value compared to other methods like FIFO, which would show higher inventory values because it sells older, cheaper stock first, while retaining the more expensive recent purchases in inventory. Thus, LIFO favors reducing taxable income in inflationary periods, making it the correct choice for this scenario.