Canadian Securities Course (CSC) Level 1 Practice Exam

How do you use the First in First Out (FIFO) method to calculate inventory?

1. Values inventory based on its current market rate.

2. Uses the last items purchased first.

3. Assumes items acquired earliest are used or sold first.

4. Calculates inventory based on the highest purchase price.

The correct answer is: Assumes items acquired earliest are used or sold first.

The First in First Out (FIFO) method is based on the principle that the oldest inventory items (the first ones acquired) are the first to be used or sold. This approach reflects the natural flow of inventory for many businesses, particularly those dealing with perishable goods where older inventory may spoil or become obsolete. By assuming that the earliest purchased items are used first, FIFO helps ensure that the cost of goods sold reflects the costs associated with the oldest inventory, thereby providing a clear representation of the cost associated with current sales. The other options do not align with the FIFO method. For instance, valuing inventory based on the current market rate does not specifically relate to FIFO's principles of inventory flow. Additionally, using the last items purchased first contradicts the FIFO approach, which focuses on the order of purchase rather than the latest inventory. Lastly, calculating inventory based on the highest purchase price pertains more to methods like Last in First Out (LIFO) rather than FIFO.