Question

If merchandise inventory is being valued at cost and the price level is decreasing, which of the three methods of costing - FIFO, LIFO, or Weighted Average cost - will yield

a. the highest inventory cost

b. the lowest inventory cost

c. the highest gross profit

d. the lowest gross profit

please explain the answer thoroughly.

Answer 1

	Answer
a. the highest inventory cost	LIFO
b. the lowest inventory cost	FIFO
c. the highest gross profit	LIFO
d. the lowest gross profit	FIFO
LIFO stands for Last in-First Out. Under this method cost of the inventory sold is taken for those inventory which has been recently(currently) purchased. For example A Inc. purchase 5 units @3/- on 2nd April and 10 Units @4/- on 5Th april and sold 5 Units on 6Th april. Then as per LIFO it will be assumed that those 5 units which are being sold on 6th are those which were purchased on 5th(most recent purchase).
Impact of LIFO on Income statement.
In income statement,an item cost of goods sold is effected by the method used for inventory valuation. In most of the cases by using LIFO cost of goods sold is higher than in other methods thereby lowering down the net income. Hence under LIFO, Net income is lower as compared to other inventory valuation method. Now lets check out why it happens, I use the words "In most of the cases" which means generally price of each item is increased during a period of time due to inflation. and LIFO uses most recent purchase value for computing cost of goods sold. So it is evident that if we will use recent value than earlier purchase value it will be higher thereby increasing cost of goods sold and lowering the net income.
Under weighted average profit and inventory cost is always a middle value of FIFO and LIFO