ACCA Audit and Assurance (F8) Practice Exam

Which is a method of efficient inventory accounting?

1. Numerical sequencing

2. FIFO

3. Incremental accounting

4. Accrued expenses method

The correct answer is: FIFO

FIFO, which stands for "First In, First Out," is a widely recognized method of inventory accounting that enhances efficiency in tracking and valuing inventory. This method operates on the principle that the oldest inventory items are sold or used before newer ones are, thus aligning with the natural flow of many types of goods. One of the primary advantages of FIFO is that during periods of inflation, it results in lower cost of goods sold and higher ending inventory values compared to other methods, such as LIFO (Last In, First Out). This can lead to higher reported profits and increased taxable income. Additionally, FIFO often provides a more accurate reflection of current market value on the balance sheet because the remaining inventory is valued at more recent purchase prices. This method also assists in minimizing obsolete stock risks since older items are sold first. It is particularly effective in industries where products have a limited shelf life, such as perishable goods. In contrast, the other methods mentioned do not provide the same level of efficiency or relevance in inventory accounting. Numerical sequencing relates more to the ordering and listing of inventory items rather than the accounting for their costs. Incremental accounting is not a standard inventory accounting method and is not commonly associated with inventory valuation. The accrued expenses method focuses on recognizing