ExpertMedium2 marksMultiple Choice
ACCA · Question 14 · Recording Transactions: Inventory
Section A
During periods of rising prices (inflation), a steel manufacturing company switches its inventory valuation method from AVCO (Average Cost) to FIFO (First-In, First-Out). What will be the impact on the reported Gross Profit and the closing inventory valuation?
Section A
During periods of rising prices (inflation), a steel manufacturing company switches its inventory valuation method from AVCO (Average Cost) to FIFO (First-In, First-Out). What will be the impact on the reported Gross Profit and the closing inventory valuation?
Answer options:
A.
Gross Profit will decrease; Closing Inventory will decrease.
B.
Gross Profit will increase; Closing Inventory will increase.
C.
Gross Profit will increase; Closing Inventory will decrease.
D.
Gross Profit will decrease; Closing Inventory will increase.
How to approach this question
Think about what FIFO means: First In, First Out. The oldest inventory is sold first. In inflation, oldest inventory is the cheapest. Cheaper Cost of Sales = Higher Gross Profit. The inventory left over is the newest, which is the most expensive. Therefore, Closing Inventory is higher.
Full Answer
B.Gross Profit will increase; Closing Inventory will increase.✓ Correct
In a period of rising prices, FIFO assumes the older, cheaper units are sold first. This results in a lower Cost of Sales and therefore a higher Gross Profit compared to AVCO. The closing inventory consists of the most recently purchased, more expensive units, resulting in a higher closing inventory valuation.
Common mistakes
Confusing the effects of FIFO and LIFO (though LIFO is not permitted under IAS 2, the logic is often confused).
Practice the full ACCA FA — Financial Accounting Practice Exam 6
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