When dealing with inventory methods and their impact on financial statements in an economy with rising costs, it's important to understand the nature of the Last In, First Out (LIFO) method.
The LIFO inventory method assumes that the last items put into inventory are the first items sold. In an environment where costs are rising, the goods that were most recently purchased (and therefore more expensive) are assumed to be sold first. Let's break down how this affects the cost of goods sold (COGS) and net income:
1. Cost of Goods Sold (COGS): Under LIFO, during periods of rising costs, the COGS recorded on the income statement will reflect the costs of the more recently acquired (and therefore higher-cost) inventory. This means that the COGS will be higher than it would be under other inventory accounting methods like First In, First Out (FIFO) or average cost.
2. Net Income: Net income is calculated as Revenue minus Costs, which includes COGS among other expenses. With a higher COGS resulting from the LIFO method during inflationary periods, the total costs subtracted from revenue will be greater. This in turn results in a lower net income reported on the financial statements.
Therefore, when applying the LIFO method in an economy with rising costs, one would expect to find a lower net income compared to other inventory valuation methods because of the higher cost of goods sold. The net income is lower due to the most recently acquired, more expensive items being considered sold first.
Given that the net income is calculated by subtracting the higher COGS from revenue during periods of rising costs when using LIFO, the correct answer is:
A. lower
This choice reflects the impact of the LIFO method on net income in the scenario described.
