Question

Which of the following inventory valuation methods minimizes income tax expense during a period of rising inventory costs?

a first-in, first-out

b. last-in, first-out

c. weighted-average

d. specific identification

Answer 1

Answer: b) last-in, first-out (LIFO) inventory valuation method minimizes income tax expense during a period of rising inventory costs.

The Inventory valuation method uses directly affected the company " Cost of good sold", which is an expense. The higher the expenses lower the net income, and hence the lower income tax liability. In usually, the first-in, first-out (FIFO) inventory valuation method will produce a higher net income,hence a higher tax liability, than the LIFO method.

An example a ABC Company buys a pen on january 1 for $50. On June 1, it buys Same pen for $60, and on October1, it buys yet another same pen for $75. On November1, the company sells one of the pens. It bought the pens at three different prices,so what cost should its cost of goods sold.

FIFO method: under the FIFO method, the first item purchased is also the first one sold. hence the cost of goods sold would be $50.Since this is the lowest-cost item in the example, profits would be highest under FIFO. hence higher the profit, higher the income tax expense.

LIFO method: under the LIFO method, the last item purchased is also the first one sold. hence the cost of goods sold would be $75.Since this is the highest-cost item in the example, profits would be lowest under LIFO. hence lower the profit, lower the income tax expense.