土豆妮

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:

A) decrease from 16.5 to 12.6%.

B) increase from 16.5 to 20.3%.

C) remain unchanged at 16.5%.

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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%.

土豆妮

If all else holds constant in periods of rising prices and inventory levels:

A) FIFO firms have higher debt to equity ratios than LIFO firms do.

B) FIFO firms will have greater stockholder's equity than LIFO firms do.

C) LIFO firms have higher gross profit margins than FIFO firms do.

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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):

• FIFO firms have lower debt to equity ratios than LIFO firms do because stockholder's equity is higher and debt is constant.
• LIFO firms have lower gross profit margins ((Sales-COGS)/Sales) because the more expensive last purchases are assigned to COGS, lowering the numerator.

土豆妮

In periods of rising prices and stable or increasing inventory quantities, using the LIFO method for inventory accounting compared to FIFO will have:

A) higher COGS, lower income, higher cash flows, and lower inventory.

B) higher COGS, lower income, lower cash flows, and lower inventory.

C) lower COGS, higher income, identical cash flows, and lower inventory.

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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.

土豆妮

The best way to compute an inventory turnover ratio is to use:

A) last in, first out (LIFO) for cost of goods sold (COGS) and first in, first out (FIFO) for average inventory.

B) last in, first out (LIFO) for both cost of goods sold (COGS) and average inventory.

C) first in, first out (FIFO) for both cost of goods sold (COGS) and average inventory.

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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.

土豆妮

When analyzing profitability ratios, which inventory accounting method is preferred?

A) Weighted average.

B) Last in, first out (LIFO).

C) First in, first out (FIFO).

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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.

土豆妮

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:

A) higher total assets and higher net income.

B) lower total assets and higher net income.

C) lower total assets and lower net income.

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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.