During periods of rising prices, which of the following is most likely to occur?
| ||
| ||
|
Under the assumptions of this question and using LIFO, the most expensive units go to COGS, resulting in lower net income.
During a period of rising prices, the financial statements of a firm using first in, first out (FIFO) reporting, instead of last in, first out (LIFO) reporting would show:
| ||
| ||
|
When the FIFO method is used when prices are rising, the cheaper goods in beginning inventory, reflecting earlier purchases, are assigned to COGS (hence, higher income) and the more expensive units (last purchases) are assigned to ending inventory (greater current assets). When the LIFO method is used during a period when prices are rising, the more expensive last purchases are assigned to COGS (hence, lower income) and the cheaper units in beginning inventory and earlier purchases are assigned to ending inventory.
When analyzing profitability ratios, which inventory accounting method is preferred?
| ||
| ||
|
Using LIFO cost of goods sold (COGS) gives a more accurate measure of future earnings because the LIFO COGS is more representative of the current cost of product sold as compared to using FIFO therefore net income will be more accurately represented.
The best way to compute an inventory turnover ratio is to use:
| ||
| ||
|
Inventory turnover makes no sense at all for firms using LIFO due to the mismatching of costs (the numerator is current while the denominator is historical). FIFO based inventory is relatively unaffected by price changes and is a good approximation of actual turnover. In this way, current costs are matched in the numerator and denominator.
Selected information from Mendota, Inc.’s financial statements for the year ended December 31 includes the following (in $):
|
Sales |
7,000,000 |
|
Cost of Goods Sold |
5,000,000 |
|
LIFO Reserve on Jan. 1 |
600,000 |
|
LIFO Reserve on Dec. 31 |
850,000 |
Mendota uses the last in, first out (LIFO) inventory cost flow assumption. The tax rate is 40%. If Mendota changed from LIFO to first in, first out (FIFO), its gross profit margin would:
| ||
| ||
|
Gross profit margin under LIFO ((sales – cost of goods sold) / sales) is (($7,000,000 ? $5,000,000) / $7,000,000) = 28.6%. Under FIFO, cost of goods sold is reduced by the increase in the LIFO reserve, and the resulting FIFO gross profit margin is (($7,000,000 – ($5,000,000 – ($850,000 - $600,000)) / $7,000,000) = 32.1%. Note that the tax rate only affects income totals after income tax expense is shown and does not affect the gross profit margin.
Selected information from Newcomb, Inc.’s financial statements for the year ended December 31, 20X4 included the following (in $):
|
Cash |
70,000 |
|
Accounts Payable |
90,000 |
|
Accounts Receivable |
140,000 |
|
Deferred Tax Liability |
100,000 |
|
Inventory |
460,000 |
|
Long-term Debt |
520,000 |
|
Property, Plant & Equip. |
1,200,000 |
|
Common Stock |
600,000 |
|
Total Assets |
1,870,000 |
|
Retained Earnings |
360,000 |
|
|
|
|
Total Liabilities & Equity |
1,870,000 |
|
Earnings Before Interest and Taxes |
280,000 |
|||
|
Interest Expense |
60,000 |
|
|
|
|
Income Tax Expense |
75,000 |
|||
|
Net Income |
145,000 |
|
|
|
|
LIFO Reserve at Jan. 1 |
185,000 |
|
|
|
|
LIFO Reserve at Dec. 31 |
250,000 |
|
|
|
If Newcomb had used first in, first out (FIFO) for 20X4 and we assume that average total capital was $1,700,000 for both the LIFO and FIFO computations, the return on total capital would:
| ||
| ||
|
The return on total capital under LIFO (EBIT / average total capital) was $280,000 / $1,700,000 = 16.5%. Under FIFO, EBIT is increased by the increase in the LIFO reserve during the year. FIFO return on total capital is ($280,000 + ($250,000 ? $185,000)) / $1,700,000 = 20.3%.
If all else holds constant in periods of rising prices and inventory levels:
| ||
| ||
|
The FIFO method of inventory accounting assigns the cost of the earliest units acquired to goods transferred out and the cost of most recent acquisitions to ending inventory. When prices are rising, the cheaper goods in beginning inventory reflecting earlier purchases are assigned to COGS (hence, higher income and higher shareholder's equity through retained earnings.) Explanations for other choices: In periods of rising prices and inventory levels (all else constant):
In periods of rising prices and stable or increasing inventory quantities, using the LIFO method for inventory accounting compared to FIFO will have:
| ||
| ||
|
In periods of rising prices and stable or increasing inventory quantities, the LIFO method – as compared with FIFO – will result in higher COGS, lower taxes, lower net income, lower inventory balances, lower working capital, and higher cash flows.
In periods of rising prices and stable or increasing inventory quantities, a company using LIFO rather than FIFO will report cost of goods sold and cash flows which are, respectively:
| COGS | Cash Flows |
| ||||
| ||||
|
In this situation, LIFO results in higher cost of goods sold because it uses the more recent and higher costs than FIFO. LIFO results in higher cash flows because with lower reported income, income tax will be lower.
During periods of declining prices, which inventory method would result in the highest net income?
| ||
| ||
|
When prices are declining and LIFO is used the COGS is smaller than if FIFO is used leading to a larger net income.
In general, when analyzing profitability and costs, or when analyzing asset and equity ratios, which of the following should be used?
| Profitability/Cost Ratios | Asset/Equity Ratios |
| ||||
| ||||
|
In general, an analyst should use LIFO when examining profitability or cost ratios and FIFO when examining asset or equity ratios.
Which of the following statements regarding inventory accounting methods is most accurate? In periods of:
| ||
| ||
|
In periods of rising prices LIFO results in lower current assets because the ending inventory is based on inventory items that were purchased first at a lower price.
During periods of rising prices:
| ||
| ||
|
FIFO inventory, and therefore FIFO assets and equity, will be higher by the LIFO reserve.
Which of the following statements concerning a period of rising prices is least accurate?
| ||
| ||
|
LIFO results in lower inventory and higher cost of goods sold (COGS) during a period of rising prices, hence a higher inventory turnover.
Assume that Hunter Round Restaurant Supply currently uses the last in, first out (LIFO) method to account for inventory and that the business environment is one of rising prices and stable or growing inventory balances. In addition, Hunter Round has an effective tax rate of zero percent due to tax loss carrybacks. All else equal, which of the following statements is least likely valid? By using LIFO instead of first in, first out (FIFO), Hunter Round has:
| ||
| ||
|
In the absence of taxes, there is no difference in cash flow between LIFO and FIFO. The other statements are true. For the examination, memorize the financial impact of rising and falling prices for the two inventory methods.
Assuming high inflation in the short run and lower levels of inflation in the long run, the current ratio of a company using last in, first out (LIFO) relative to a firm using first in, first out (FIFO), will be:
| ||
| ||
|
The LIFO firm's current ratio will be lower and the difference between the two firms' current ratios will increase as inflation decreases. For example, assume purchases equal sales so the quantity of inventory is constant. Inventory value under LIFO will also remain constant as inflation decreases, whereas FIFO inventory value will increase even as the inflation rate decreases. As long as inflation remains positive, the FIFO inventory value and the difference between LIFO and FIFO inventory values will increase, as will the difference between the LIFO and FIFO firms' current ratios.
| 欢迎光临 CFA论坛 (http://forum.theanalystspace.com/) | Powered by Discuz! 7.2 |