Question

Current Attempt in Progress The management of Milque Corp. is considering the effects of various inventory-costing methods on its financial statements and its income tax expense. Assuming that the price the company pays for inventory is increasing, which method will: (a) provide the highest net income? (b) provide the highest ending inventory? LIFO FIFO Average Cost (c) result in the lowest income tax expense? (d) result in the most stable earnings over a number of years?

Answer 1

Solution a:

Provide the highest Net Income = FIFO

This is because when prices is increasing, FIFO method will provide Lowest cost of goods sold as goods are sold from earliest inventory. Therefore, due to lower cost of goods sold, Net Income will be Highest.

Solution b:

Provide the highest ending inventory = FIFO

This is because, Under FIFO method, inventory consists of latest purchases and when prices are increasing, ending inventory will be highest cost.

Solution c:

Result in Lowest income tax expense = LIFO

This is because when prices is increasing, LIFO method will provide highest cost of goods sold as goods are sold from latest purchases. Therefore, due to highest cost of goods sold, Net Income will be lowest and consequently, it results in lowest income tax expense.

Solution d:

Result in most stable earnings over a number of years = Average cost.

This is because under average cost method, average cost is applied to both cost of goods sold and ending inventroy and hence it provides stable earnings over a number of years.