CFA Practice Question

There are 520 practice questions for this study session.

CFA Practice Question

Which of the following statements is false?
A. The use of FIFO will lead to a meaningful inventory turnover.
B. The use of FIFO will understate the debt-to-equity ratio and overstate income.
C. Cash flows are improved under LIFO.
Explanation: Inventory turnover will be distorted under both LIFO and FIFO. Because FIFO uses earlier, lower costs for cost of goods sold, inventory turnover will likely be too low. Under LIFO, the inventory value is too low, which can lead to inventory turnover that is too high.

User Contributed Comments 11

User Comment
kalps LIFO - inventory is the closing stock vlaued at low price therefore inventory valuation is too high FIF - Inventory is all the latest expensive stock therefore inventory valuation is too low.
humphrey B should be false too: FIFO overstate profit, overstate equity, understate debt equity ratio, is that right?
fielddar Your explaination is correct. However, that is what B says, so it is true, not false.
gjwhite It is best to use: Current Cost = (Lifo COGS)/(Fifo Invent). But the empirical evidence is that the current cost ratio and Fifo inventory turnover are not materially different if prices are not rising too fast (refer to pps 276-277 of text).
zactompson The choice of LIFO or FIFO has no impact on debt. Since FIFO results in higher inventory value, it reports higher equity so as to reconcile the balance sheet. Therefore, debt-to-equity ratio will be lower under FIFO. Therefore statement of B is correct and should NOT be chosen.
zidane007 First it should be specified if prices are rising or falling. As we don't have this information we cannot determine if LIFO or FIFO will understate or overstate something or if the effect on cash flows is positive or negative. So B or C is neither correct nor false. But as the answers tell us the use of LIFO or FIFO will not lead to a meaningful inventory turnover. And this is independent from rising or falling prices...
So we have to chosse A because B or C is potentially correct, but A is always a wrong statement!
LIEJON Why are Cash Flows improved under LIFO, can anybody explain?
gazman1984 Cash flows impoved due to tax
jpducros Since we don't know if prices are rising or not, how can we say that LIFO will lead to higher COGS, thus lower tax ?
oregane If not given, assume prices are going up.
Nishhhhh Inventory turnover is calculated using ending inventory, which is a balance sheet item. I thought any analysis that consist of balance sheet items, FIFO is the preferred value and LIFO is preferred for income statement values.
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