Tax 2-3 Identify an advantage or disadvantage of a particular method of inventory valuation.

Question 1

Question 4 of 30

Which of the following is a correct statement regarding the FIFO method of accounting for inventory?

a. During periods of declining inventory prices, lower taxable income will result.
b. During periods of increasing inventory prices, the cost of goods sold (COGS) will be higher.
c. During periods of increasing inventory prices, lower taxable income will result.

(LO 2-3)

Answer 1

a. During periods of declining inventory prices, lower taxable income will result.

Under the FIFO method, more expensive inventory will be treated as sold first during a period of declining prices, resulting in a higher COGS, thus lowering taxable income.

Question 2

Question 5 of 30

Which one of the following is a correct statement regarding the LIFO method of accounting for inventory?

a. During periods of declining inventory prices, lower taxable income will result.
b. During periods of declining inventory prices, the cost of goods sold (COGS) will be higher.
c. During periods of increasing inventory prices, lower taxable income will result.

(LO 2-3)

Answer 2

c. During periods of increasing inventory prices, lower taxable income will result.

Under the LIFO method, when prices are increasing, COGS will be higher, and thus, taxable income will be lower.

Question 3

Question 20 of 30

Which one of the following forms of inventory valuation provides the greatest flexibility in managing inventory?

first-in, first-out (FIFO)

last-in, first-out (LIFO)

specific identification

(LO 2-3)

Answer 3

specific identification

The major advantage of the specific identification method is that it allows maximum flexibility in managing inventory. For example, if the taxpayer has two identical inventory items, he or she may choose to sell the higher- or lower-cost item.

Question 4

The major advantage of _____ is that in a period of rising prices, a deferral of income taxes occurs because the higher-priced inventory items are matched against revenue. Another major advantage is improved cash flow, which results from the income tax deferral. Also, a more realistic financial picture is presented because the more recent costs are matched against current revenues. Remember that the cost of goods sold, not the inventory purchases, is the deductible expense. The major disadvantages of _____ are perceived to be reduced earnings and understated inventory. Earnings are often lower using _____, and many corporate managers perceive the lower profits as a disadvantage. The inventory understatement is due to the oldest costs being shown in ending inventory on the balance sheet.

specific identification method

first in, first out (FIFO)

last in, first out (LIFO)

(LO 2-3)

Answer 4

the last in, first out (LIFO) method of inventory valuation.

Question 5

The major non-tax advantage associated with _____ is a higher earnings figure in times of inflation, which many business managers prefer. Also, in a time of declining prices, the reported earnings are decreased because the higher-priced inventory items are matched against revenues. From a financial accounting perspective, the advantage of _____ is that the ending inventory figure is representative of a current cost (replacement) figure. The major disadvantage associated with _____ is the higher earnings in inflationary times, which obviously results in a greater tax liability.

specific identification method

first in, first out (FIFO)

last in, first out (LIFO)

(LO 2-3)

Answer 5

the first in, first out (FIFO) method of inventory valuation.

Question 6

The _____ may be used when it is possible to physically identify the items purchased; in other words, it may be used when a fairly small number of easily identifiable items are carried in inventory. Examples are automobiles, custom jewelry, and certain types of equipment. This method may be advantageous because it is very easy to use.

specific identification method

first in, first out (FIFO)

last in, first out (LIFO)

(LO 2-3)

Answer 6

the specific identification method of inventory valuation

Question 7

Practice Test 1

13. Which of the following statements regarding inventory valuation techniques are correct?

I. During a period of rising prices, LIFO increases the cost of goods sold.

II. During a period of declining prices, LIFO increases the cost of goods sold.

III. During a period of rising prices, FIFO increases the cost of goods sold.

IV. During a period of declining prices, FIFO increases the cost of goods sold.

I and III only

I and IV only

II and III only

II and IV only

(LO 2-3)

Answer 7

I and IV only

During a period of rising prices, the last-in, first-out method treats the higher-priced inventory items as those first sold. This therefore increases the cost of goods sold. Conversely, during a period of declining prices, the first-in, first-out method matches the higher-priced inventory items against income. This naturally increases the cost of goods sold.

Question 8

37. Which one of the following is a correct statement regarding the FIFO method of accounting for inventory?
    a. During periods of declining inventory prices, lower taxable income will result.
    b. During periods of increasing inventory prices, the cost of goods sold will be higher.
    c. During periods of increasing inventory prices, lower taxable income will result.

(LO 2-3)

Answer 8

a. During periods of declining inventory prices, lower taxable income will result.

Under the FIFO method, more expensive (earlier-purchased) inventory will be treated as sold first during a period of declining prices. This results in an increased cost of goods sold (COGS), thus lowering taxable income.