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To increase net income, revenues must be at their highest and expenses at their lowest. Cost of goods sold (COGS) is usually a company's greatest expense and therefore it should be minimized where possible.
In a periodic system, inventory is taken at the end of every fiscal period. The value of COGS and ending inventory is calculated at the end of this period. The cost of goods that are purchased and those from the beginning inventory are added to give the cost of goods available for sale. From this amount, the ending inventory is subtracted to give the COGS. As we can see, the ending inventory decreases the COGS expense. The only value that needs to be manipulated when using the periodic system is the ending inventory, and as a consequence, cost of goods sold. Therefore, to obtain the lowest value for the COGS, the ending inventory should be at its highest possible value. If current inventory prices are at their lowest, the most recent items will have the lowest cost and the older items will be of higher values. Since the highest value is wanted for the ending inventory, the items purchased first will be used for ending inventory. This leaves the most recently purchased items to be considered the first to be sold. The LIFO (Last In, First Out) inventory valuation method accomplishes just that.
In a perpetual system, inventory is updated as items is sold. Therefore, the exact number of items sold in a fiscal period is known. The ending inventory is irrelevant since its value is not required to calculate net income. As in the periodic system, a low value is needed for COGS. Since recent prices are low, the items purchased last should be recorded as having been sold first. Hence, the LIFO inventory valuation method would be used.
To show a high net income when current inventory prices are decreasing, the cost of goods sold must be at current market prices and the ending inventory at the past cost. Therefore, the LIFO inventory valuation method would be used in either a periodic or a perpetual system.