ExpertMedium2 marksMultiple Choice
ACCA · Question 28 · Recording Transactions: Inventory
Section A
During a period of consistently rising prices, a company is deciding whether to use the First-In, First-Out (FIFO) or the Average Cost (AVCO) method for inventory valuation.
Compared to AVCO, what will be the effect of using FIFO on the company's gross profit and closing inventory valuation?
Section A
During a period of consistently rising prices, a company is deciding whether to use the First-In, First-Out (FIFO) or the Average Cost (AVCO) method for inventory valuation.
Compared to AVCO, what will be the effect of using FIFO on the company's gross profit and closing inventory valuation?
Answer options:
A.
Higher gross profit and lower closing inventory valuation.
B.
Lower gross profit and higher closing inventory valuation.
C.
Higher gross profit and higher closing inventory valuation.
D.
Lower gross profit and lower closing inventory valuation.
How to approach this question
Think about which costs go where. FIFO means older (cheaper) items are sold, so Cost of Sales is lower, making Profit higher. Newer (expensive) items remain in inventory, making Closing Inventory higher.
Full Answer
C.Higher gross profit and higher closing inventory valuation.✓ Correct
In a period of rising prices, older inventory is cheaper. FIFO assumes the oldest inventory is sold first, resulting in a lower Cost of Sales and therefore a higher Gross Profit compared to AVCO. The closing inventory under FIFO consists of the most recent, more expensive purchases, resulting in a higher closing inventory valuation.
Common mistakes
Confusing the impact of FIFO vs LIFO (though LIFO is not permitted under IAS 2, the logic is often tested).
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