ExpertMedium2 marksMultiple Choice
ACCA · Question 15 · Cost accounting techniques
In a period of consistently rising commodity prices, a company is considering switching its inventory valuation method from AVCO (Average Cost) to FIFO (First-In, First-Out).
What will be the impact on reported profit and closing inventory valuation?
In a period of consistently rising commodity prices, a company is considering switching its inventory valuation method from AVCO (Average Cost) to FIFO (First-In, First-Out).
What will be the impact on reported profit and closing inventory valuation?
Answer options:
A.
Reported profit will be lower, and closing inventory will be lower.
B.
Reported profit will be higher, and closing inventory will be higher.
C.
Reported profit will be higher, but closing inventory will be lower.
D.
Reported profit will be lower, but closing inventory will be higher.
How to approach this question
Think about which costs are expensed under FIFO (the oldest, cheapest ones) versus AVCO (a blend). Lower expenses mean higher profit. The remaining inventory under FIFO is the newest, most expensive stock.
Full Answer
B.Reported profit will be higher, and closing inventory will be higher.✓ Correct
During inflation, FIFO matches older, lower costs against current revenues, resulting in a lower Cost of Sales and higher gross profit compared to AVCO. Closing inventory consists of the most recent, higher-priced purchases, so its value is higher than under AVCO.
Common mistakes
Confusing the effects of FIFO with LIFO (which is not permitted under IAS 2 but often tested conceptually).
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