Inventory Valuation – FIFO Impact

Practice Question

Intro to Financial Accounting
Cost of Sales and Inventory Management
Inventory Valuation Methods (FIFO, WAC)
MCQs

How does the FIFO method of inventory valuation impact the financial statements during a period of rising prices?

Answer +
Correct Answer: D
Explanation +

The FIFO (First-In, First-Out) method of inventory valuation assumes that the oldest inventory items are sold first. During periods of rising prices, this means that the cost of goods sold will be lower because it reflects the older, cheaper costs of inventory.

Consequently, this results in a higher ending inventory value on the balance sheet and a higher gross profit on the income statement. This can lead to increased taxable income, as higher profits could result in higher income tax liabilities.