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Basic Question 9 of 16

Which of the following statements is true in an inflationary environment?

A. Under FIFO, income will tend to be understated.
B. Under LIFO, working capital may be distorted.
C. Under FIFO, cash flows will be increased.
D. The use of FIFO will cause debt-to-equity ratios to be overstated.
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User Contributed Comments 6

User Comment
stranger a. in FIFO income is overstated since COGS is understated b. IN LIFO COGS IS OVERSTATED AND INVENTORY UNDERSTATED, THE INCOME TAX SAVINGS CAUSING BETTER CASH FLOW DO NOT GIVE SUFFICIENT CONTER EFFECT AND HENCE WORKING CAPITAL IS STATED LOWER c. in FIFO cash flows decreas because of higher income and hence higher taxes d. this is a possible answer since higher income becomes part of equity in FIFO and causes higher debt-to-equity ratio
melissatt This question and question 8 is basically the same. So, why is it that in question 8, the answer is D-to-E ratio is overstated, but in THIS question, the answer is B? I mean, shouldn't (D) be the correct answer as well?
hkcfa melissatt: in Q 8 the answer is D-to-E ratio is understated, not overstated.
mordja FIFO -> increase Equity -> understatement of D/E ratio as denominator increases. Therefore can not be D.
past1sttime distorted can mean up or down
ashish100 typing in all caps has the opposite effect. i totally skipped that dudes comment. no need to yell guys.
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Colin Sampaleanu

Colin Sampaleanu

Learning Outcome Statements

calculate and explain how inflation and deflation of inventory costs affect the financial statements and ratios of companies that use different inventory valuation methods

CFA® 2024 Level I Curriculum, Volume 2, Module 6.