CFA Practice Question
Which of the following is (are) true under GAAP?
II. Marketable securities are always carried at acquisition cost.
III. For income tax purposes, LIFO is preferable to FIFO during inflation.
I. Inventories can only be "written down" but not "written up."
II. Marketable securities are always carried at acquisition cost.
III. For income tax purposes, LIFO is preferable to FIFO during inflation.
A. I, II & III
B. III only
C. I & III
Explanation: (I) is true since inventory is valued at the lower-of-cost-or-market (LCM). (II) is not true since some marketable securities (Trading securities) are carried at current market value. Finally, when prices are rising, the COGS under LIFO is higher than that under FIFO, leading to lower tax payments.
User Contributed Comments 5
| User | Comment |
|---|---|
| sireklove | The Analysis and Use of Financial Statements books states: GAAP requires the use of the lower-of-cost-or-market-valuation basis for inventories . . . which follows the principle of conservatism since it recognizes losses ore declines in market value as they occur, whereas increases are reported only when inventory is sold. Held-to-maturity securities may be classified as short-term (marketable securities) or long-term and are recorded at cost and valued on the balance sheet at cost adjusted for the effects of interest. That would make II false as it is currently phrased since there are marketable securities that are carried at acquisition cost. |
| sireklove | . . . sorry, I meant II true as it is currently phrased. It would make the given answer (III only) incorrect. |
| johnny | sireklove: notice the 'always' in II. |
| julescruis | If you recognise an impairment on inventory as of 31/12/2006 for example, the inventory is written down. If however in the subsequent period you recognise that the value is going up again (as for commodities or precious metals) you are allowed to "write up" the inventory back to the original book value, hence I is not entirely correct. Nevermind I guess, we are not here to learn about accounting anyway... |
| jerasmus | julescruis: Under IFRS that is true, but under US GAAP reversal of write-downs are prohibited. |