National Association of Boards of Long Term Care Administrator (NAB) CORE Practice Exam

The LIFO and FIFO methods of inventory costing account for the effects of which factor?

1. Salvage value

2. Depreciation

3. Supply and demand

4. Inflation and deflation

The correct answer is: Inflation and deflation

The correct answer focuses on how the LIFO (Last In, First Out) and FIFO (First In, First Out) inventory costing methods are influenced by changes in pricing over time, particularly during periods of inflation and deflation. LIFO assumes that the most recently acquired inventory items are the first to be used or sold. In times of inflation, this can result in recognizing higher costs of goods sold and potentially lower profits for the period, as the company is matching the latest, more expensive inventory against revenues. Conversely, FIFO assumes that the oldest inventory items are sold first. During inflationary periods, this approach can lead to lower cost of goods sold and higher profits, as it reflects the older, typically cheaper costs associated with the inventory. Both methods essentially reflect how these economic factors — inflation and deflation — affect the financial outcomes of the business by altering the reported costs of inventory and affecting net income. In a deflationary scenario, LIFO may lead to higher profits and valuation on older inventory, while FIFO would reflect lower costs on recently acquired items. Thus, recognizing the impact of inflation and deflation is crucial for decision-making related to pricing, inventory valuation, and financial reporting.