Question

Comparing Inventory Methods Assume that a firm separately determined inventory under FIFO and LIFO and then compared the results. a. In each dropdown that follows, select the correct sign [less than (<), greater than (>), or equal (=)] for each comparison, assuming periods of rising prices. 1. FIFO inventory LIFO inventory 2. FIFO cost of merchandise sold LIFO cost of merchandise soldd 3. FIFO net income LIFO net income 4. FIFO income taxes LIFO income taxes b. Why would management prefer to use LIFO over FIFO in periods of rising prices? The income shown on the company’s tax return would be lower if LIFO rather than FIFO were used; thus, there is a tax advantage of using LIFO. The inventory value would be lower if LIFO rather than FIFO were used; thus, there is a tax advantage of using LIFO. The income shown on the company’s tax return would be higher if LIFO rather than FIFO were used ; thus giving a better dividend to the shareholders.

Answer 1

Answer a:

Correct signs [less than (<), greater than (>), or equal (=)] are inserted as below:

Assuming periods of rising prices:

1. FIFO inventory > LIFO inventory

2. FIFO cost of merchandise sold < LIFO cost of merchandise sold

3. FIFO net income > LIFO net income

4. FIFO income taxes > LIFO income taxes

Explanation:

In periods of rising prices, compared to LIFO, FIFO will result in lower cost goods sold, higher inventory, higher income, higher income tax.

Answer b:

Correct answer is:

The income shown on the company’s tax return would be lower if LIFO rather than FIFO were used; thus, there is a tax advantage of using LIFO.

Explanation:

Management prefer to use LIFO over FIFO in periods of rising prices, since LIFO will result in higher cost of goods sold, lower taxable income and lower taxes. As such option A is correct.

Options B is also correct however option A is more appropriate.

Option C is incorrect since the income shown on the company’s tax return would be lower if LIFO rather than FIFO were used.