### Inventory Costing Methods and Managerial Bonus Incentives **Question:** The managers of Teng Company receive performance bonuses based on the net income of the company. Which inventory costing method are they likely to favor in periods of declining prices? **Options:** - Weighted Average - FIFO - LIFO - Specific Identification **Explanation:** Inventory costing methods can significantly impact the net income of a company, especially during periods of fluctuating prices. Managers who receive bonuses based on net income have a direct interest in the method that will best improve financial outcomes. Below, we explore the different methods and their potential impacts on net income: 1. **Weighted Average:** - This method averages out the cost of inventory, providing a cost that is between the highest and lowest prices paid for goods. It may not necessarily favor higher or lower income results during price declines. 2. **First-In, First-Out (FIFO):** - FIFO assumes that the oldest inventory items are sold first. In periods of declining prices, the older, higher-cost items are sold first, leaving the newer, lower-cost items in inventory. This can result in a higher net income as cost of goods sold (COGS) will reflect the older, higher prices, making the remaining inventory cheaper. 3. **Last-In, First-Out (LIFO):** - LIFO assumes that the most recently purchased items are sold first. In periods of declining prices, this means the newer, lower-cost items are sold first, which can reduce COGS and thus increase net income. However, LIFO is generally favored in periods of rising prices to reduce taxable income. 4. **Specific Identification:** - This method tracks the actual cost of each specific item, which can be useful for items that are easy to identify individually but doesn’t typically offer broad financial advantages in terms of net income. **Preferred Method in Declining Prices:** Given that the managers of Teng Company receive bonuses based on the net income, they are likely to favor the **FIFO method** during periods of declining prices. FIFO allows them to report lower COGS and higher profits by utilizing higher historical costs and preserving lower cost inventory for future periods. Understanding the nuances of these inventory costing methods can help in optimal financial decision-making and aligning management incentives with company performance.