Under inflationary conditions, how does the LIFO inventory method affect taxes and reported profits?

• A. When prices rise, LIFO yields higher COGS and lower taxable income.
• B. LIFO always increases taxes
• C. LIFO has no tax impact
• D. LIFO reduces COGS

Answer: (A)

In an inflationary environment, the cost flow under LIFO uses the most recently purchased, higher-cost items to compute cost of goods sold. That means COGS is pushed up when prices rise, which reduces gross profit and, after considering all expenses, lowers reported net income. Since taxes are tied to taxable income, this higher COGS under LIFO typically reduces taxes. (Note: ending inventory tends to reflect older, lower costs, which is another side effect of LIFO.)