Which accounting method typically results in lower taxable income during rising prices?

Which accounting method typically results in lower taxable income during rising prices?

• A. FIFO
• B. LIFO
• C. Average Cost
• D. Standard Cost

Answer: (B)

The correct answer is LIFO, which stands for Last-In, First-Out. This accounting method assumes that the most recently acquired inventory items are sold first. During periods of rising prices, the cost of goods sold under LIFO will be higher because the newer inventory purchased at higher prices is recognized as an expense first. As a result, this leads to lower taxable income since expenses are higher, and therefore, profits—and subsequently taxes—are lower. In contrast, FIFO (First-In, First-Out) would yield a higher taxable income during inflationary periods, as it allocates the older, cheaper costs to cost of goods sold while the newer, more expensive inventory remains on the balance sheet. Average Cost would smooth out the effects of price fluctuations and typically does not lead to the same significant tax benefits as LIFO in an inflationary environment. Standard Cost focuses on budgeting and controlling costs rather than addressing the values of inventory sold and is not specifically designed to influence taxable income in relation to pricing fluctuations.

The correct answer is LIFO, which stands for Last-In, First-Out. This accounting method assumes that the most recently acquired inventory items are sold first. During periods of rising prices, the cost of goods sold under LIFO will be higher because the newer inventory purchased at higher prices is recognized as an expense first. As a result, this leads to lower taxable income since expenses are higher, and therefore, profits—and subsequently taxes—are lower.

In contrast, FIFO (First-In, First-Out) would yield a higher taxable income during inflationary periods, as it allocates the older, cheaper costs to cost of goods sold while the newer, more expensive inventory remains on the balance sheet. Average Cost would smooth out the effects of price fluctuations and typically does not lead to the same significant tax benefits as LIFO in an inflationary environment. Standard Cost focuses on budgeting and controlling costs rather than addressing the values of inventory sold and is not specifically designed to influence taxable income in relation to pricing fluctuations.