Which inventory costing method tends to yield the highest reported profits in a rising-price environment?

Which inventory costing method tends to yield the highest reported profits in a rising-price environment?

• A. LIFO
• B. FIFO
• C. Weighted Average
• D. Specific Identification

Answer: (B)

In a rising-price environment, the cost flow method that tends to produce the highest reported profits is FIFO. This works because FIFO assigns the oldest (and typically cheaper) costs to cost of goods sold. With costs rising, COGS becomes lower under FIFO, which boosts gross profit and net income. The ending inventory then reflects the newer, higher costs, raising asset values on the balance sheet. LIFO, by using the most recent (higher) costs for COGS, increases COGS and lowers profits. Weighted average smooths costs and falls between, and specific identification can vary depending on which items are sold. But overall, FIFO more often yields higher reported profits when prices are rising.

In a rising-price environment, the cost flow method that tends to produce the highest reported profits is FIFO. This works because FIFO assigns the oldest (and typically cheaper) costs to cost of goods sold. With costs rising, COGS becomes lower under FIFO, which boosts gross profit and net income. The ending inventory then reflects the newer, higher costs, raising asset values on the balance sheet. LIFO, by using the most recent (higher) costs for COGS, increases COGS and lowers profits. Weighted average smooths costs and falls between, and specific identification can vary depending on which items are sold. But overall, FIFO more often yields higher reported profits when prices are rising.