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CFA Level I · CFA Level I Exam · Analysis of Inventories

An analyst compares two retailers that sell identical goods. Retailer X uses FIFO and Retailer Y uses weighted average cost. Purchase prices have been rising steadily for several years and inventory levels are stable. Compared with Retailer Y, Retailer X's inventory turnover is most likely:

Retailer X's inventory turnover is most likely lower. Under FIFO in a period of rising prices, cost of sales is lower and ending inventory is higher than under weighted average cost, so cost of sales divided by average inventory falls.

  1. Ahigher, because its cost of sales is larger
  2. Blower, because its ending inventory is carried at more recent costsCorrect
  3. Cthe same, because the cost flow assumption does not affect ratios

Explanation

In rising prices FIFO gives lower cost of sales and higher ending inventory than weighted average cost. Turnover is cost of sales divided by average inventory, so a lower numerator and higher denominator produce a lower ratio. The first option reverses the direction of the effect on cost of sales.

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