Question content area FIFO reports higher gross profit and net income than the LIFO method when

Last in, first out (LIFO) is a method used to account for inventory that records the most recently produced items as sold first. Under LIFO, the cost of the most recent products purchased (or produced) are the first to be expensed as cost of goods sold (COGS), which means the lower cost of older products will be reported as inventory.

Two alternative methods of inventory-costing include first in, first out (FIFO), where the oldest inventory items are recorded as sold first, and the average cost method, which takes the weighted average of all units available for sale during the accounting period and then uses that average cost to determine COGS and ending inventory.

Last in, first out (LIFO) is a method used to account for inventory.
Under LIFO, the costs of the most recent products purchased (or produced) are the first to be expensed.
LIFO is used only in the United States and governed by the generally accepted accounting principles (GAAP).
Other methods to account for inventory include first in, first out (FIFO) and the average cost method.
Using LIFO typically lowers net income but is tax advantageous when prices are rising.

Last in, first out (LIFO) is only used in the United States where all three inventory-costing methods can be used under generally accepted accounting principles (GAAP). The International Financial Reporting Standards (IFRS) forbids the use of the LIFO method.

Companies that use LIFO inventory valuations are typically those with relatively large inventories, such as retailers or auto dealerships, that can take advantage of lower taxes (when prices are rising) and higher cash flows.

Many U.S. companies prefer to use FIFO though, because if a firm uses a LIFO valuation when it files taxes, it must also use LIFO when it reports financial results to shareholders, which lowers net income and, ultimately, earnings per share.

When there is zero inflation, all three inventory-costing methods produce the same result. But if inflation is high, the choice of accounting method can dramatically affect valuation ratios. FIFO, LIFO, and average cost have a different impact:

FIFO provides a better indication of the value of ending inventory (on the balance sheet), but it also increases net income because inventory that might be several years old is used to value COGS. Increasing net income sounds good, but it can increase the taxes that a company must pay.
LIFO is not a good indicator of ending inventory value because it may understate the value of inventory. LIFO results in lower net income (and taxes) because COGS is higher. However, there are fewer inventory write-downs under LIFO during inflation.
Average cost produces results that fall somewhere between FIFO and LIFO.

If prices are decreasing, then the complete opposite of the above is true.

Assume company A has 10 widgets. The first five widgets cost $100 each and arrived two days ago. The last five widgets cost $200 each and arrived one day ago. Based on the LIFO method of inventory management, the last widgets in are the first ones to be sold. Seven widgets are sold, but how much can the accountant record as a cost?

Each widget has the same sales price, so revenue is the same, but the cost of the widgets is based on the inventory method selected. Based on the LIFO method, the last inventory in is the first inventory sold. This means the widgets that cost $200 sold first. The company then sold two more of the $100 widgets. In total, the cost of the widgets under the LIFO method is $1,200, or five at $200 and two at $100. In contrast, using FIFO, the $100 widgets are sold first, followed by the $200 widgets. So, the cost of the widgets sold will be recorded as $900, or five at $100 and two at $200.

This is why in periods of rising prices, LIFO creates higher costs and lowers net income, which also reduces taxable income. Likewise, in periods of falling prices, LIFO creates lower costs and increases net income, which also increases taxable income.

•FIFO reports higher gross profit and net income than the LIFO method whencosts (prices) are increasing.•However, in periods of rapidly rising costs, the inventory that is sold must bereplaced at increasingly higher costs. ○In such cases, the larger FIFO gross profit and net income are sometimes called inventory profits or illusory profits. •During a period of increasing costs, LIFO matches more recent costs against sales on the income statement. •LIFO also offers an income tax savings during periods of increasing costs. ○This is because LIFO reports the lowest amount of gross profit and, thus, lower taxable net income. •However, under LIFO, the ending inventory on the balance sheet may be quite different from its current replacement cost.•The weighted average cost method is, in a sense, a compromise between FIFO and LIFO.•The effect of cost (price) trends is averaged in determining the cost of goodssold and the ending inventory. Reporting Inventory in the Financial Statements•Cost is the primary basis for valuing and reporting inventories in the financial statements. However, inventory may be valued at other than cost inthe following cases:○The cost of replacing items in inventory is below the recorded cost.○The inventory cannot be sold at normal prices due to imperfections, style changes, spoilage, damage, obsolescence, or other causes.Valuation at Lower of Cost or Market•If the market is lower than the purchase cost, the lower-of-cost-or-market (LCM) method is used to value the inventory.•Market, as used in lower of cost or market, is the net realizable valueof theinventory. Net realizable value is determined as follows:Net Realizable Value = Estimated Selling Price – Direct Costs of Disposal○Direct costs of disposal include selling expenses such as special advertising or sales commissions.Inventory on the Balance Sheet•Inventory is usually reported in the current assets section of the balance sheet.•In addition to this amount, the following are reported:○The method of determining the cost of the inventory (FIFO, LIFO, or weighted average)