FIFO Questions

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 C. The use of FIFO will overstate income D. Cash flows are improved under LIFO Correct Answer: D. Explanation: Inventory turnover will be distorted under both LIFO and FIFO. Because FIFO uses earlier, lower costs for cost of goods sold, the inventory turnover will likely be too low. Under LIFO, the inventory value is too low, which can lead to an inventory turnover that is too high. Why is D, I thought the choice of LIFO/FIFO has no effect on pretax cash flow? thank you -J

sorry I am so stupid the question is asking which one is fales :slight_smile:

ya, the question asks for which one is FALSE, so D is false and the other 3 are true…

The major assumption is are the prices rising or falling. RISING PRICE UNDER LIFO: Profit comes down and thus Cash flow. FALLING PRICE UNDER LIFO: Profit goes up and thus increased cash flow. It mean when prices are rising the cash flow will be reduced under LIFO. Thus correct answer is D?

Answer is clearly ‘D’ since Cash Flows are never affected by the inventory accounting methods… - Dinesh S

yes the answe is D. sorry i am such wasting your time… i should read the question carefully before i post anything :frowning: thank you for all the replies -J

Dinesh S, What about after tax cash flows?

pass528 Wrote: ------------------------------------------------------- > Dinesh S, > > What about after tax cash flows? dunno how taxes affect cash flows, hope someone would shed some light on this? any takers? - Dinesh S

My understanding When Taxes increase – NI goes down. So when you calculate CFO with the indirect method – and NI is your starting point, you are starting with a lower figure. So higher taxes – leads to lower CFO Lower taxes – means a higher CFO. Even in the direct method – you start with Cash from Customers - Cash used in Production - Other Cash Expenses - Cash Interest Paid - Cash Taxes Paid So CFO gets affected. In FIFO with rising prices – COGS is lower, so NI is higher, so Taxes is higher, so CFO is lower. LIFO - rising prices - COGS (current and higher), NI lower, taxes lower, so CFO is compared to FIFO higher. With falling prices – the situation is the exact opposite of the rising prices scenario above. HTH CP

I’m a bit confused. I think the right answer to this one is B. Cash flows should be affected

Pre tax cash flows are not affected- because LIFO/FIFO is simply an allocation of already existing cash flows. Post tax cash flows will be affected as with rising prices, LIFO will “overstate” the COGS, and thus “understate” the income, and thus the taxes payable will be less. This is actually a major incentiv for LIFO based costing.