honeycfa

Selected information from Jenner, Inc.’s financial statements for the year ended December 31 included the following (in $):

Cash	$200,000	Accounts Payable	$300,000
Accounts Receivable	300,000	Deferred Tax Liability	600,000
Inventory	1,500,000	Long-term Debt	8,100,000
Property, Plant & Equip.	11,000,000	Common Stock	2,200,000
Total Assets	13,000,000	Retained Earnings	1,800,000
LIFO Reserve at Jan. 1	400,000	Total Liabilities & Equity	$13,000,000
LIFO Reserve at Dec. 31	600,000
Net Income
(after 40% tax rate)	800,000

Jenner uses the last in, first out (LIFO) inventory cost flow assumption. If Jenner changed from LIFO to first in, first out (FIFO) in 2001, return on total equity would:

A) increase from 20.0 to 23.0%.

B) decrease from 20.0 to 18.3%.

C) increase from 20.0 to 21.1%.

---

Return on total equity (net income / total equity) was ($800,000 / ($2,200,000 + $1,800,000) =) 20%. Under FIFO, net income increases by the increase in the LIFO reserve multiplied by (1 – tax rate). FIFO net income for 2001 was ($800,000 + ($600,000 – $400,000) (1 – 0.40) = ) $920,000. Total equity increases by the amount of accumulated FIFO profits that are added to retained earnings which is calculated by multiplying the amount of the ending LIFO reserve by (1 – tax rate) for an increase of (($600,000) * (1 – 0.40) =) $360,000. Total equity is ($2,200,000 + $1,800,000 + $360,000 =) $4,360,000. FIFO return on total equity is ($920,000 / $4,360,000 =) 21.1%.

honeycfa

Given the following information and assuming beginning inventory was zero what is the gross profit at the end of the period using the FIFO, LIFO, and average cost methods?

Purchases	Sales
20 units at $50	15 units at $60
35 units at $40	35 units at $45
85 units at $30	85 units at $35

FIFO

LIFO

Cost Average

A) $650 $750 $677

B) $650 $750 $990

C) $677 $650 $677

---

FIFO: $5,450 ? 4,800 = $650

LIFO: $5,450 ? $4,700 = $750

Cost Average: $5,450 ? $4,773.21 = $676.79

honeycfa

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:

A) increase to 40.1%.

B) increase to 32.1%.

C) increase to 30.0%.

---

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.

honeycfa

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

A) FIFO FIFO

B) LIFO FIFO

C) FIFO LIFO

---

In general, an analyst should use LIFO when examining profitability or cost ratios and FIFO when examining asset or equity ratios.

honeycfa

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

A) Weighted average.

B) First in, first out (FIFO).

C) Last in, first out (LIFO).

---

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.

honeycfa

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

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

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

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

---

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.

honeycfa

	Units	Unit Price
Beginning Inventory	709	$2.00
Purchases	556	$6.00
Sales	959	$13.00
SGA Expenses	$2,649 per annum

What are the earnings before taxes using the FIFO method and LIFO method?

FIFO

LIFO

A) $6,900 $5,506

B) $6,900 $5,676

C) $6,213 $5,676

---

FIFO COGS = (709 units)($2/unit) + (959 ? 709)($6/unit) = $1,418 + $1,500 = $2,918

Sales = (959 units)($13/unit) = $12,467

EBIT = Sales ? COGS ? Expenses

= 12,467 ? 2,918 ? 2,649 = $6,900

LIFO COGS = (556 units)($6/unit) + (959 ? 556)($2/unit) = $3,336 + $806 = $4,142

Sales = (959 units)($13/unit) = $12,467

EBIT = Sales ? COGS ? Expenses = 12,467 ? 4,142 ? 2,649 = $5,676