CFA Practice Question
During a time of rising prices, compared to FIFO:
A. LIFO gives lower Liquidity and higher ratio of COGS to Average Inventory.
B. LIFO gives higher Liquidity and higher ratio of COGS to Average Inventory.
C. LIFO gives higher Liquidity and lower ratio of COGS to Average Inventory
Explanation: LIFO has higher COGS (as newer inventory is more expensive than older inventory) and this results in lower taxes (= higher liquidity).
User Contributed Comments 5
| User | Comment |
|---|---|
| Clude | Are people getting lazy? Why not comment on this? Liquidity(CA/CL for example), during inflation - LIFO def. gives lower current ratio. |
| HTale | As per the CFA readings, liquidity measurements are either Cash Conversion Cycle, CA/CL, Quick Ratio or Cash Ratio. CCC is reduced because with LIFO, you have a higher inventory turnover, given that you have higher COGS and a lower average inventory. All else equal, this would mean your inventory DOH is shorter, which would mean a lot more cash available to pay your debtors. |
| Kathkun | thx Htale, I always wrongly used current ratio as liquidity for these questions. Now I know better |
| Fernie | I dont see why CA/CL cant be used here. For me it is a fair measurement of liquidity and hence, A does apply... any comments guys? |
| harrybay | Yeah agree with Fernie, CCC and CA/CL are both measures of liquidity. What is certain is that in no way LIFO gives higher liquidity. |