Question

what would be the effect on the Cost of goods sold, Ending inventory, net income and income tax if the prices of inventory are decreasing (deflation).
Using LIFO and FIFO

Answer 1

FIFO:

Cost of Goods sold: When the prices are decreasing, the cost of goods sold will increase as the stock with higher cost will be assumed to be sold first.

Ending Inventory: The cost of ending inventory will decrease as the stock that will form the finished goods is the most recent one having the lower prices.

Net Income: As the cost of goods sold will increase in the FIFO method, the net income will decrease because as the revenue will remain constant but with increase in cost of goods sold, the net income is tend to decrease.

Income Tax: The income tax is dependent upon the net income and is a percentage of net income. As the net income will decrease, the income tax will also decrease in FIFO method.

LIFO:

Cost of Goods sold: The cost of goods sold will decrease as the stock with lower cost will be assumed to be sold first in the LIFO method.

Ending Inventory: The cost of ending inventory will increase because the stock that will form the finished goods is the oldest one having the highest prices.

Net Income: As the cost of goods sold will decrease, the net income will increase because as the revenue will remain constant but with decrease in cost of goods sold, the net income is tend to increase.

Income Tax: The income tax is dependent upon the net income and is a percentage of net income. As the net income will increase, the income tax will also increase in LIFO method.