Can someone please help me with this Question? (Question 20, CFAI Volume 2, Pg 45)
Any write-downs of inventory are least likely to have a significant effect on the inventory valued using;
A. Weighted Avg cost
B. FIFO
C. LIFO
My understanding is that Inventories valued under LIFO are less likely to incur write downs as they value their inventories at the oldest & presumably cheaper prices. Still if write down occours,it is likely to be of a lesser magnitude. Hence wouldnt the answer be C… that inventory write down using LIFO inventory Valuation is least likely to have significant effect on Inventory??
The excerpt states that, “increased competition may lead to lower unit sales and excess production capacity and excess inventory. This may result in a further downward price pressure”. The downward price pressure could lead to inventory that is valued above the current market prices or NRV. Any write-downs of inventory are least likely to have a significant effect on the inventory valued using;
(I’m wondering if by “significant effect on the inventory” they mean as a percentage of the inventory price. If that’s what they mean (and it’s by no means clear), then I could see B as the correct answer: FIFO inventory will give you the highest inventory value, so if it drops by a given amount it will be a lower percentage of the FIFO value than of a LIFO or average value.)
If prices have been decreasing, writedowns under FIFO are least likely to have significant effect because the inventory is valued at closer to the new, lower prices.
That assumes that prices have been declining for long enough that they’re at or below the historical prices that would appear in LIFO inventory. That’s a huge assumption, one that requires for its justification a lot more background data than they provided.
