What is the primary effect of using FIFO during a period of rising prices?
Practice Questions
1 question
Q1
What is the primary effect of using FIFO during a period of rising prices?
Higher net income
Lower net income
No effect on net income
Higher tax liability
Using FIFO during rising prices results in higher net income because older, cheaper costs are matched against current revenues.
Questions & Step-by-step Solutions
1 item
Q
Q: What is the primary effect of using FIFO during a period of rising prices?
Solution: Using FIFO during rising prices results in higher net income because older, cheaper costs are matched against current revenues.
Steps: 5
Step 1: Understand FIFO. FIFO stands for 'First In, First Out'. This means that the oldest inventory costs are used up first when calculating expenses.
Step 2: Recognize rising prices. When prices are rising, the cost of new inventory is higher than the cost of older inventory.
Step 3: Calculate costs. Under FIFO, when you sell products, you are using the older, cheaper costs for your expenses.
Step 4: Compare revenues and expenses. Since your revenues are based on the current, higher prices, but your expenses are based on the older, lower costs, this creates a larger profit margin.
Step 5: Determine net income. Higher profit margins lead to higher net income because you are subtracting lower costs from higher revenues.
