CFA Level I · CFA Level I Exam · Financial Analysis Techniques
An analyst compares the current ratio of a retailer that values inventory using FIFO with that of a peer that uses weighted average cost, in a period of rising prices. Which statement best describes the main limitation this creates for the comparison?
Differing inventory cost-flow methods can make the ratios less comparable. In rising prices FIFO gives higher inventory and a higher current ratio than weighted average cost, so the analyst must adjust for policy differences before comparing the two retailers.
- ADiffering inventory methods can make the ratios less comparableCorrect
- BThe ratios are identical because both firms sell similar goods
- CBoth ratios are overstated by the same proportion
Explanation
With rising prices, FIFO reports higher ending inventory than weighted average cost, which raises current assets and the current ratio. Differences in accounting policies reduce comparability unless the analyst adjusts the figures. The other options wrongly assume equal effects.
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