In times of rising prices, inventory profits (or phantom profits) are said to occur under the FIFO cost flow assumption. This occurs because under FIFO, the release of older, lower costs to the income statement results in higher profits than if current costs were to be recognized. This creates a problem for the reporting company because:?

The answer is overstate profits

Explanation:

FIFO is First in First out. It assumrs that the oldest goods purchased or manufactured are sold first and the newest goods purchased or manufactured remain in ending inventory. With this, the cost of sales shows the cost of sales shows the cost of goods in the beginning inventory and the value of ending inventory reflects the cost of goods purchased more recently.

Therefore, in the period of rising inventory ending inventory are higher, cost of sales are lower and this makes profit to be higher or being overstated