University of Central Florida (UCF) ACG3173 Accounting for Decision-Makers Exam 2 Practice

Using the Last-In, First-Out (LIFO) method during inflationary periods results in lower taxable income. This occurs because LIFO matches the more recent, higher costs of inventory against revenues. As prices rise, the cost of goods sold (COGS) calculated under LIFO increases, which reduces the company’s reported profits. Consequently, with lower profits, the company faces lower taxable income.

This is particularly beneficial for businesses seeking to manage their cash flow and tax liabilities during periods of rising prices, as it allows them to defer tax payments. The approach effectively reflects the current costs of inventory rather than the historical costs, providing a more accurate representation of the economic realities faced by the business under inflationary conditions.

In contrast, higher reported profits, lower COGS, or higher ending inventory values would not typically apply to LIFO in an inflationary environment. Higher reported profits and higher ending inventory values are more characteristic of methods like FIFO (First-In, First-Out), where older, cheaper costs remain in COGS, resulting in inflated profit figures during inflation. Lower COGS would contradict the effect seen with LIFO during inflation, since the method raises COGS relative to FIFO.