Question

As compared with the FIFO method of costing inventories, does the LIFO method result in a larger or smaller net income in a period of rising prices? What is the comparative effect on net income in a period of falling prices?

Short answer

In case of rising price trend, FIFO is a suitable method, and in case of falling price, trend LIFO is suitable.

Step-by-step solution

FIFO vs. LIFO in case of rising prices

FIFO is based on the historic cost method. So the issued inventories are valued at the earliest cost of acquisition. Thus under the FIFO method, the current price rising to tend does not affect the inventory valuation, and the net income is free from the inflation effect.

On the contrary, under the LIFO method, the current cost is used for valuing inventory. Current cost is affected by the rising price trend reflect the inflation effect.

So, the LIFO method is affected the rising price trend.

FIFO vs. LIFO in case of falling prices

In case of falling prices, the FIFO may represent a cost lower higher than the current cost level. So under FIFO, inventory can be overvalued in case of a falling price trend.

On the contrary, the LIFO may represent the lover inventory value in case of falling prices as the valuation is done on the current cost level.