Gross Income and Inventory Methods increase, whether, decrease, reported, require

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An analyst has determined that Megamore Industries uses the LIFO inventory method.
Megamore’s reported gross income for the year is most likely to be overstated and require
adjustment by the analyst if, during the year, Megamore experienced a(n):
A. increase in inventory prices.
B. decrease in inventory prices.
C. increase in inventory quantities.
D. decrease in inventory quantities.

Answer: D


Is this assuming inflation? It gives no indication of whether inventory prices rose or fell during the quarter.

JGovender

A. When inventory prices increase, LIFO Accounting will always Understate Gross Income and not Overstate. So, this is not a correct answer.

B. When inventory prices decrease, Gross Income under LIFO Accounting will be Overstated, but it should not require any adjustment from analyst other than LIFO to FIFO conversion, if required to compare a LIFO firm with a FIFO firm. So, this is not the correct choice.

C. Increase in inventory quantities is not a correct choice, as it should not require adjustment under rising or declining prices.

D. Decreasing inventory quantities is the correct choice. It means, you are not purchasing any new inventories and are eating up from your previous stock. Now, your previous stock is cheaper, so you see your Gross Income increased. But why this needs adjustment by Analyst is because, eating up from your prior inventory is not sustainable. At some point you are going to exhaust your old inventory and would not be able to continue to have increased Gross Income based on this.

Flok

So if I understand this correctly, essentially what the question is getting at is forecasting future earnings. Since were assuming the adjustment by the analyst is that they will need to account for buying inventories at higher prices into the thier future forecasts. Is my thinking correct?

lc26mizzou

Absolutely.