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Hello everyone,
I’m working through the Kaplan F3 question bank and I’ve got to this question:
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In the year ended 31 August 20X4, Aplus’ records show closing inventory of 1,000 units compared to 950 units of opening inventory.
Which of the following statements is true assuming that prices have fallen throughout the year?
A Closing inventory and profit are higher using FIFO rather than AVCO.
B Closing inventory and profit are lower using FIFO rather than AVCO.
C Closing inventory is higher and profit lower using FIFO rather than AVCO.
D Closing inventory is lower and profit higher using FIFO rather than AVCO.—
The answer was B.
However, I’m a bit confused.
If closing inventory is valued at a lower price, doesn’t this mean that you will have a greater profit, because your margin is greater?
Revenue – Cost of sales = Gross Profit.
If the “Cost of sales” figure (Inventory price) is lower, you take less off the revenue, and aren’t your profits therefore greater?
I’d be really grateful if somebody could explain this in simple terms to me!
Thank you very much in advance!
Andrew
Hi Andrew
This is what I think
If you valued the inventory to lower price you have higher cost of sale.To calculate the cost of sale;
Example 1 Example 2
Opening invetory 1000 1000
+ Purchase 500 500
– Closing inventory (400) (300)= Cost of sale 1100 1200
Revenue – Cost of sale = Gross Profit
Let say that revenue is 2000, then
Example 1
2000-1100 = 900 of Gross Profit
Example 2
2000 -1200 = 800 of Gross ProfitBecause in the question is saying that the prices are fallen, than by using FIFO that profit will be lower.
In order to reply to this question it is important to remember how to calculate the cost of sale, that is not only the closing inventory but the result of the formula that you see above.
I hope this example can help you
Gabbi
Gabbi, many thanks for taking the time to reply. I see my error in understanding now.
Thank you! 🙂
Closing inventory may be valued using first-in, first-out (FIFO) or average cost (AVCO).
Which of the following statements is true assuming that prices have fallen throughout the
year?A Closing inventory and profit are higher using FIFO rather than AVCO
B Closing inventory and profit are lower using FIFO rather than AVCO
C Closing inventory is higher and profit lower using FIFO rather than AVCO
D Closing inventory is lower and profit higher using FIFO rather than AVCOThe right option is B, can I get an explaination for this?
When prices are falling throughout the year, using FIFO (First-In, First-Out) means that the older, higher-priced inventory is sold first. This results in:
Higher Cost of Goods Sold : Since the older, more expensive inventory is being used up first, the cost of goods sold will be higher.
Lower Profit: With a higher cost of goods sold, the profit will be lower.
Lower Closing Inventory Value: The remaining inventory is valued at the more recent, lower prices.
Therefore the answer is B. Hope this helps.
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