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What is the primary effect of using FIFO during inflationary periods?

Practice Questions

Q1
What is the primary effect of using FIFO during inflationary periods?
  1. Higher net income
  2. Lower net income
  3. No effect on net income
  4. Higher inventory valuation

Questions & Step-by-Step Solutions

What is the primary effect of using FIFO during inflationary periods?
  • Step 1: Understand FIFO. FIFO stands for 'First In, First Out'. This means that the oldest inventory items are sold first.
  • Step 2: Recognize inflation. Inflation is when prices of goods and services increase over time.
  • Step 3: Connect FIFO and inflation. When prices rise, the older inventory (which was bought at lower prices) is sold first.
  • Step 4: Calculate cost of goods sold (COGS). Since the older, cheaper items are sold first, the COGS will be lower.
  • Step 5: Determine net income. With lower COGS, the revenue from sales minus COGS results in a higher net income.
  • Step 6: Conclude the effect. Therefore, using FIFO during inflation leads to higher net income.
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