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Financial Statement AnalysisModule 6 of 9

Inventory Analysis: FIFO, LIFO, Turnover, and Write-Downs

5

Concepts

4

Formulas

1

Decisions

4

Quiz Questions

What this CFA Level 1 inventory reading covers

Inventory analysis asks how cost flow assumptions and write-down rules affect reported profitability, assets, taxes, and ratios. For Level 1, the common exam move is to compare FIFO, LIFO, and weighted average results, then adjust LIFO companies to a FIFO basis for comparability.

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FIFO, LIFO, and Inventory Ratios Compared

TopicFormula or ruleCFA Level 1 exam angleInterpretation
FIFO in rising pricesOldest costs flow to COGS firstReports lower COGS, higher net income, higher inventory, and higher taxes.Balance sheet inventory is closer to current replacement cost.
LIFO in rising pricesNewest costs flow to COGS firstReports higher COGS, lower net income, lower inventory, and tax savings under US GAAP.Income can be conservative, but inventory may be understated.
LIFO reserveFIFO Inventory = LIFO Inventory + LIFO ReserveUsed to restate a LIFO company to FIFO for cross-company comparison.A rising reserve usually means FIFO inventory exceeds LIFO inventory by more over time.
Inventory turnoverCOGS / Average InventoryMeasures how quickly inventory is sold or used in production.Higher turnover can signal efficiency, but very high turnover can also signal stockout risk.
Days of inventory365 / Inventory TurnoverConverts turnover into the average number of days inventory is held.Lower days is usually faster conversion, but context matters by industry.

Inventory turnover in CFA Level 1

Inventory turnover equals cost of goods sold divided by average inventory. Candidates should know that higher turnover generally means faster inventory movement, but it must be interpreted relative to industry norms and possible stockout risk.

FIFO vs LIFO exam shortcut

In rising prices, FIFO reports higher income and higher inventory than LIFO. LIFO reports lower income and lower inventory, but may improve operating cash flow through lower taxes where LIFO is allowed.

IFRS and US GAAP inventory differences

IFRS prohibits LIFO and allows reversal of some inventory write-downs when net realizable value recovers. US GAAP allows LIFO but does not allow inventory write-down reversals.

Practice Prompts

  1. 1Calculate inventory turnover from COGS and average inventory, then convert it into days of inventory.
  2. 2Given rising prices, rank FIFO, LIFO, and weighted average by reported income and ending inventory.
  3. 3Use the LIFO reserve to convert reported LIFO inventory into FIFO inventory.
  4. 4Explain why LIFO liquidation can temporarily inflate profit.

Key Concepts

5 concepts covered in this module.

FIFO

First In, First Out. Ending inventory reflects recent costs (closer to replacement cost). In rising prices: higher income, higher inventory.

LIFO

Last In, First Out (US GAAP only). COGS reflects recent costs. In rising prices: lower income (tax savings), lower inventory, better cash flow.

Weighted Average

Average cost of all units available. Results fall between FIFO and LIFO.

LIFO Reserve

Difference between LIFO and FIFO inventory values. Disclosed by LIFO companies. Used to convert LIFO to FIFO for comparison.

Inventory Write-Down

IFRS: lower of cost or NRV (reversals allowed). US GAAP: lower of cost or market (no reversals).

Formulas

4 essential formulas for this module.

FIFO Inventory from LIFO

FIFO Inventory = LIFO Inventory + LIFO Reserve

Where: To make LIFO companies comparable to FIFO

FIFO COGS from LIFO

FIFO COGS = LIFO COGS - ΔLIFO Reserve

Where: Δ = change in LIFO reserve during period

Inventory Turnover

Inv Turnover = COGS / Average Inventory

Where: Higher = faster inventory movement

Days of Inventory

DOH = 365 / Inventory Turnover

Where: Days to sell inventory

Decision Frameworks

1 decision frameworks to guide your analysis.

FIFO vs LIFO in rising prices?

  • FIFO: higher income, higher BS inventory, higher taxes
  • LIFO: lower income, lower taxes (cash flow benefit), lower BS inventory

Mind Map

Visual overview of how concepts connect in this module.

Inventory Analysis
Methods
FIFO
LIFO (GAAP only)
Weighted Average
Specific Identification
Rising Prices Impact
FIFO: higher income, higher inventory
LIFO: lower income, tax savings
WA: between FIFO and LIFO
LIFO Reserve
FIFO Inv = LIFO + Reserve
FIFO COGS = LIFO - ΔReserve
Conversion for comparability
Write-Downs
IFRS: NRV, reversals OK
GAAP: market, no reversals
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FIFO

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Answer
First In, First Out. Ending inventory reflects recent costs (closer to replacement cost). In rising prices: higher income, higher inventory.
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