If a company uses FIFO, how does it affect the balance sheet during inflation?
Practice Questions
1 question
Q1
If a company uses FIFO, how does it affect the balance sheet during inflation?
Assets are overstated
Liabilities are overstated
Equity is understated
No effect
Using FIFO during inflation can lead to an overstatement of assets on the balance sheet because older, cheaper inventory costs are recorded.
Questions & Step-by-step Solutions
1 item
Q
Q: If a company uses FIFO, how does it affect the balance sheet during inflation?
Solution: Using FIFO during inflation can lead to an overstatement of assets on the balance sheet because older, cheaper inventory costs are recorded.
Steps: 5
Step 1: Understand FIFO - FIFO stands for 'First In, First Out'. This means that the oldest inventory costs are used up first when calculating costs.
Step 2: Recognize inflation - Inflation means that prices are generally rising over time, so newer inventory costs more than older inventory.
Step 3: Apply FIFO during inflation - When a company sells products, it records the cost of the older, cheaper inventory first due to FIFO.
Step 4: Impact on balance sheet - Since the company is using older, cheaper costs, the value of the remaining inventory on the balance sheet appears higher than it actually is.
Step 5: Conclusion - Therefore, using FIFO during inflation can lead to an overstatement of assets on the balance sheet.
