Combination for Lowest Income Tax

A

In the earlier years, this combination results in the lowest income reported and hence, the lowest taxes.

To determine which combination leads to the lowest income tax paid in earlier years of a firm, we need to consider the effects of different inventory valuation methods (FIFO and LIFO) and depreciation methods (straight-line and double declining balance) on taxable income.

1. FIFO (First-In, First-Out) inventory valuation method assumes that the first items purchased are the first ones sold. This results in lower cost of goods sold (COGS) and higher ending inventory values compared to LIFO.

2. LIFO (Last-In, First-Out) inventory valuation method assumes that the last items purchased are the first ones sold. This results in higher COGS and lower ending inventory values compared to FIFO.

3. Straight-line depreciation method allocates an equal amount of depreciation expense over the useful life of an asset. This results in a consistent deduction from taxable income each year.

4. Double declining balance depreciation method accelerates the depreciation expense in earlier years, assuming that the asset's value declines more rapidly initially and slows down over time. This results in higher depreciation expense and lower taxable income in the earlier years.

Now, let's analyze each combination:

I. FIFO (Inventory Valuation) + Straight-line (Depreciation): This combination results in lower COGS due to the FIFO method, which reduces taxable income. However, the straight-line depreciation method does not significantly affect taxable income. Overall, this combination does not lead to the lowest income tax paid in earlier years.

II. LIFO (Inventory Valuation) + Straight-line (Depreciation): This combination results in higher COGS due to the LIFO method, which increases taxable income. The straight-line depreciation method does not offset this increase. Therefore, this combination does not lead to the lowest income tax paid in earlier years.

III. FIFO (Inventory Valuation) + Double declining balance (Depreciation): This combination reduces COGS through the FIFO method, leading to lower taxable income. Additionally, the double declining balance depreciation method accelerates the depreciation expense, further reducing taxable income. Therefore, this combination may result in the lowest income tax paid in earlier years.

IV. LIFO (Inventory Valuation) + Double declining balance (Depreciation): This combination increases COGS due to the LIFO method, resulting in higher taxable income. The double declining balance depreciation method may partially offset the increase but is not sufficient to lead to the lowest income tax paid in earlier years.

Based on the analysis, the combination that leads to the lowest income tax paid in earlier years of a firm is III. FIFO (Inventory Valuation) + Double declining balance (Depreciation). Therefore, the correct answer is D. III.