What happens to net income when inventory costs decrease and FIFO is used?

When inventory costs decrease and the FIFO (First-In, First-Out) method is used, the impact on net income can be understood through the way FIFO records inventory costs. Under FIFO, the oldest inventory costs are used to determine the cost of goods sold (COGS).

When inventory costs drop, the cost associated with the older inventory (which is now cheaper) will be reflected in the COGS. Consequently, if the inventory costs decrease, this will lead to a reduction in COGS, assuming sales prices remain constant. A lower COGS will increase the gross margin, which in turn increases the net income.

In summary, when inventory costs decline and FIFO is applied, the decrease in COGS contributes to a higher net income, thus making this the correct conclusion about the relationship between inventory cost changes and net income.