If a company uses FIFO for inventory valuation, what effect does it have on the balance sheet during inflation?
Practice Questions
1 question
Q1
If a company uses FIFO for inventory valuation, what effect does it have on the balance sheet during inflation?
Assets are understated.
Assets are overstated.
Liabilities are understated.
Equity is unaffected.
Under FIFO during inflation, older, cheaper inventory costs remain on the balance sheet, leading to an overstatement of assets.
Questions & Step-by-step Solutions
1 item
Q
Q: If a company uses FIFO for inventory valuation, what effect does it have on the balance sheet during inflation?
Solution: Under FIFO during inflation, older, cheaper inventory costs remain on the balance sheet, leading to an overstatement of assets.
Steps: 5
Step 1: Understand what FIFO means. FIFO stands for 'First In, First Out', which means the oldest inventory costs are used up first when calculating costs.
Step 2: Recognize what happens during inflation. Inflation means that prices are rising, so newer inventory costs more than older inventory.
Step 3: Identify how FIFO affects inventory costs. Under FIFO, the older, cheaper inventory costs are recorded on the balance sheet.
Step 4: Realize the impact on the balance sheet. Since the older, cheaper costs are used, the total value of inventory (assets) appears higher than it actually is.
Step 5: Conclude that during inflation, using FIFO can lead to an overstatement of assets on the balance sheet.
