What differentiates LIFO from FIFO inventory accounting?

LIFO (Last In, First Out) and FIFO (First In, First Out) are two different methods of inventory accounting that influence how companies value their inventory and report their cost of goods sold (COGS). The correct answer accurately captures the essence of how each method operates regarding cost assignment.

In LIFO, the costs associated with the most recently purchased inventory items are assigned to the cost of goods sold first when items are sold. This means that in a period of rising prices, LIFO will typically result in higher COGS and lower taxable income since newer costs, which are higher, are matched against revenue first. Consequently, the older costs remain in inventory, which can impact the balance sheet.

Conversely, FIFO follows the principle of selling the oldest inventory first. When using FIFO, the oldest costs are matched with revenue, which means that during times of inflation, the COGS will be lower compared to LIFO because the less expensive, older costs are used for the calculations. As a result, FIFO tends to result in higher taxable income and higher reported asset values on the balance sheet.

The other options do not accurately reflect this fundamental distinction. For instance, the incorrect choices either reverse the definitions of LIFO and FIFO or incorrectly state