If the economy began experiencing a prolonged period of deflation in which the prices of most goods are falling, many firms would find that the LIFO method of inventory valuation would result in higher reported profits.

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The last-in, first-out (LIFO) inventory valuation technique would base the cost of goods sold on the items most recently put in inventory. In a period of falling prices, this would result in a lower cost of goods sold because the most recently purchased items are lower in price. Since cost of goods sold is subtracted from revenue as part of the process of computing net income, LIFO would result in a higher reported net income.

If the Economy Began Experiencing a Prolonged Period of Deflation