Financial Statement Analysis. 12 question(s) in this unit's pool
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already answered and when each is next due.
Financial Statement AnalysisAnalysis of Inventories
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Question 1Exam level
A company uses LIFO. At year-end, its LIFO inventory is $400,000 and the LIFO reserve is $90,000. If an analyst converts the company's financials to a FIFO basis, the FIFO inventory value is closest to:
A. You might subtract the LIFO reserve instead of adding it, confusing the direction of adjustment. FIFO inventory is always higher than LIFO inventory in rising prices. The reserve is added to LIFO to get FIFO.
B. You might ignore the reserve entirely and report LIFO inventory unchanged. No adjustment means no conversion. The LIFO reserve must be incorporated.
Unit: analysis-of-inventories
Question 2Exam level
A company reports LIFO COGS of $800,000. The LIFO reserve increased from $50,000 to $80,000 during the year. The FIFO-equivalent COGS is closest to:
How sure are you?
Correct: A. The correct answer is $770,000.
B. You might confuse the LIFO reserve level ($80,000) with a beginning-period figure and make no adjustment. The relevant figure is the change in LIFO reserve, not its ending balance.
C. You might add the change in LIFO reserve rather than subtract it, again getting the direction wrong. FIFO COGS is lower than LIFO COGS in rising prices. The reserve increase is subtracted.
Unit: analysis-of-inventories
Question 3Exam level
A firm purchases 100 units at $10, then 100 units at $12. It sells 150 units. Under FIFO, COGS is closest to:
How sure are you?
Correct: B. The correct answer is $1,600.
A. You might use weighted-average cost: ($10 + $12)/2 = $11 × 150 = $1,650, or miscalculates. FIFO specifies the order in which cost layers are consumed, not an average.
C. You might apply LIFO logic (sell newest first): 100 × $12 + 50 × $10 = $1,700. This is LIFO COGS, not FIFO.
Unit: analysis-of-inventories
Question 4Exam level
Under LIFO, a company's current ratio is 1.8. The LIFO reserve is $200,000, total current liabilities are $500,000. The approximate FIFO current ratio is closest to:
How sure are you?
Correct: C. The correct answer is 2.2.
A. You might forget that adding LIFO reserve to inventory increases current assets. The LIFO reserve must be added to current assets to convert to FIFO basis.
B. You might only partially adjusts or makes arithmetic error. Full LIFO reserve addition of $200,000 to $900,000 current assets yields $1,100,000 / $500,000 = 2.2.
Unit: analysis-of-inventories
Question 5Exam level
Which of the following statements about LIFO liquidation is most accurate?
How sure are you?
Correct: B. The correct answer is LIFO liquidation occurs when inventory quantities sold exceed quantities purchased, drawing down old lower-cost layers.
A. The word 'liquidation' and a method 'switch' sound related conceptually. LIFO liquidation is a physical inventory depletion event, not an accounting method change.
C. You might confuse the effect direction. LIFO normally gives higher COGS, so they assume any LIFO event reduces profit. LIFO liquidation produces the opposite effect: lower COGS from old cheap layers, resulting in temporarily higher gross profit.
Unit: analysis-of-inventories
Question 6Exam level
A company operating under IFRS is evaluating three inventory cost methods. Which method(s) is most likely the company permitted to use?
How sure are you?
Correct: B. The correct answer is FIFO and weighted-average cost.
A. You might over-restrict IFRS. They know LIFO is prohibited but forget weighted-average is also permitted. Both FIFO and weighted-average are allowed under IAS 2.
C. This is correct under US GAAP. You might confuse GAAP and IFRS rules. LIFO is prohibited under IFRS. Only US GAAP permits LIFO.
Unit: analysis-of-inventories
Question 7Exam level
During a period of rising prices, compared to a company using FIFO, a company using LIFO will most likely report:
How sure are you?
Correct: B. The correct answer is Higher COGS, lower net income, lower ending inventory.
A. This describes FIFO characteristics. You might swap the two methods. These are FIFO effects. LIFO produces the opposite in rising prices.
C. You might correctly identifies COGS and inventory effects but confuses the income effect. Higher COGS means lower gross profit, lower pre-tax income, and lower net income. Not higher.
Unit: analysis-of-inventories
Question 8Exam level
A LIFO firm's financial statements show: LIFO inventory = $600,000; LIFO reserve = $150,000; tax rate = 30%. An analyst converts the firm to a FIFO basis. The after-tax adjustment to retained earnings is closest to:
How sure are you?
Correct: A. The correct answer is $105,000.
B. You might forget to apply the tax rate, reporting the gross pre-tax LIFO reserve as the equity adjustment. The tax effect must be deducted. Higher FIFO income means higher taxes, reducing the net equity benefit.
C. You might add the tax (rather than multiplies by the after-tax complement): $150,000 + $150,000 × 0.30 = $195,000. The tax is a cost, not an addition. After-tax = pre-tax × (1 - tax rate).
Unit: analysis-of-inventories
Question 9Harder
A company switched from LIFO to FIFO during the year. Under US GAAP, this change in accounting principle most likely requires:
How sure are you?
Correct: B. The correct answer is Retrospective application. Restatement of all prior period financial statements presented.
A. You might confuse accounting estimate changes (prospective) with accounting principle changes (retrospective). Inventory method changes are accounting principle changes, not estimate changes. They require retrospective restatement.
C. You might vaguely recall regulatory involvement in major accounting changes. No SEC pre-approval is required; companies must disclose and retrospectively apply the change.
Unit: analysis-of-inventories
Question 10Exam level
The LIFO reserve on a US GAAP company's balance sheet footnote is most likely described as:
How sure are you?
Correct: B. The correct answer is The cumulative difference between the inventory value that would have been reported under FIFO and the inventory value reported under LIFO.
A. LIFO does produce tax savings, and candidates conflate this with the reserve definition. The LIFO reserve is an inventory valuation difference, not a tax account. The deferred tax liability is a separate balance sheet item.
C. You might confuse LIFO reserve with inventory write-down allowances (LCM/NRV adjustments). The LIFO reserve has nothing to do with net realizable value. It is a cost method difference.
Unit: analysis-of-inventories
Question 11Above the exam
A company reports under LIFO with a LIFO reserve that increased from $80,000 to $110,000 during the year, in a period of rising costs. LIFO cost of goods sold was $900,000. Combining the LIFO reserve mechanics with the FIFO-equivalent adjustment, FIFO cost of goods sold for the same year is closest to:
How sure are you?
Correct: B. FIFO COGS = LIFO COGS - the increase in the LIFO reserve during the year = $900,000 - ($110,000 - $80,000) = $900,000 - $30,000 = $870,000. In a period of rising costs, LIFO COGS is higher than FIFO COGS would be (LIFO expenses the most recent, higher-cost inventory first), so converting from LIFO to FIFO requires SUBTRACTING the change in the reserve, not adding it.
A. $930,000 adds the full ENDING LIFO reserve balance ($900,000 + $30,000, treating the change as if it were the whole reserve) rather than adding or subtracting only the CHANGE in the reserve during the year, which is the relevant adjustment for a flow measure like COGS.
C. $1,010,000 adds the change in the reserve to LIFO COGS instead of subtracting it, reversing the direction of the adjustment; in rising-cost conditions LIFO COGS is higher than FIFO COGS, so the reserve's increase must be subtracted to arrive at the lower FIFO figure.
Unit: analysis-of-inventories
Question 12Above the exam
A company switches its inventory costing method from LIFO to FIFO for external reporting purposes, in a period of steadily rising input costs. Combining the effect on cost of goods sold with the effect on the current ratio, this switch will most likely:
How sure are you?
Correct: B. Under rising costs, FIFO expenses the OLDEST (cheapest) inventory first, leaving the most recent (most expensive) purchases in ending inventory; this means FIFO COGS is LOWER and ending inventory is HIGHER than under LIFO. Since inventory is a current asset, a higher ending inventory raises current assets and therefore raises the current ratio (current assets / current liabilities), holding current liabilities constant.
A. This reverses both effects: FIFO lowers COGS relative to LIFO in a rising-cost environment (not raises it), and the resulting higher ending inventory raises, not lowers, the current ratio.
C. While it is true that TOTAL costs over the entire life of the inventory are identical under any method (methods only affect timing), that does not mean COGS and the current ratio are unaffected in ANY GIVEN YEAR; within a single period, the choice of method clearly changes both figures, which is exactly what this LOS tests.