- CFA Exams
- CFA Level I Exam
- Topic 4. Financial Statement Analysis
- Learning Module 6. Analysis of Inventories
- Subject 1. Inventory Valuation
CFA Practice Question
Capitalization of inventory costs that should otherwise be expensed will ______
II. overstate ending inventory value.
III. understate profitability.
IV. understate ending inventory value.
I. overstate profitability.
II. overstate ending inventory value.
III. understate profitability.
IV. understate ending inventory value.
Correct Answer: I and II
Capitalizing inventory-related costs defers their recognition as an expense in the income statement until the inventory is sold.
User Contributed Comments 7
| User | Comment |
|---|---|
| mbowa | This is clearly explained |
| Diruuk | You think? |
| ascruggs92 | II is correct but I is not. Incorrectly capitalizing expenses may overstate profitability for the current period, but the expense is realized either through COGS when sold or through a write off, so overall profitability is unchanged. In fact, capitalizing costs incorrectly will lead to a lower gross margin, which makes the company appear less profitable |
| dada | If I capitalize my inventory my profitability will be overstated. True, isn't it? @ascruggs92: I got your point but I think by default we should consider the current period only. |
| syazwan21 | Also COGS only includes those that are sold in the current period. When capitalizing inventory costs, all costs associated with inventory including those that were not sold are included. Thats why the profitability is overstated. |
| choas69 | simple explaination is if u capitalize your expenses that shouldve been expensed : 1- less operating expense in I/S leads to higher profit. 2- carrying amount of goods available for sale in inventory will be higher and oversatted. correct me if iam wrong. |
| ibrahim18 | @choas69. This is such a very lovely explanation. Thanks |