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Chapter 2: Q7DQ_b (page 75)

Inflation can have significant effects on income statements and balance sheets, and therefore on the calculation of ratios. Discuss the possible impact of inflation on the following ratios, and explain the direction of the impact based on your assumptions.

b. Inventory turnover

Short Answer

Expert verified

If the company uses the LIFO method, inflation will overstate the turnover ratio. If the company uses the FIFO method, inflation may understate the ratio.

Step by step solution

01

Impact of Inflation on Inventory turnover, when a company uses the FIFO method of accounting:

First In, First Out (FIFO) is a method of accounting where assets acquired first are disposed of first.

When an organization uses the FIFO method during inflation, the cost of goods sold decreases, and the lower cost of goods sold resultsin a lower inventory turnover ratio.

02

Impact of Inflation on Inventory turnover, when a company uses the LIFO method of accounting:

Last In, First Out (LIFO) is a method of accounting where assets acquired last are disposed of first.

When an organization uses the LIFO method during inflation, the cost of goods sold increases, which would result in higher inventory turnover ratios.

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Most popular questions from this chapter

Inflation can have significant effects on income statements and balance sheets, and therefore on the calculation of ratios. Discuss the possible impact of inflation on the following ratios, and explain the direction of the impact based on your assumptions. (LO3-5)

c. Fixed asset turnover

The Haines Corp. shows the following financial data for 20X1 and 20X2:

20X1

20X2

Sales

\(3,230,000

\)3,370,000

Cost of goods sold

2,130,000

2,850,000

Gross profits

\(1,100,000

\)520,000

Selling and administrative expenses

298,000

227,000

Operating profits

\(802,000

\)293,000

Interest expense

47,200

51,600

Income before taxes

\(754,800

\)241,400

Taxes (35%)

264,180

84,490

Income after tax

\(490,620

\)156,910

For each year, compute the following and indicate whether it is increasing or

decreasing profitability in 20X2 as indicated by the ratio:

c. Interest expenses to sales

Prepare an income statement for Virginia Slim Wear. Take your calculations all the way to computing earnings per share.

Sales

1,360,000

Shares outstanding

104,000

Cost of goods sold

700,000

Interest expenses

34,000

Selling and administration expenses

49,000

Depreciation expenses

23,000

Preferred stock dividend

86,000

Taxes

100,000

Using the income statement for Times Mirror and Glass Co., compute the following ratios:

The total assets for this company equal \(80,000. Set up the equation for the Du Pont system of ratio analysis, and compute c, d, and e.

c. Profit margin.

Times mirror and glass company

Sales

\)126,000

Less: Cost of goods sold

93,000

Gross profit

\(33,000

Less: selling and administrative expenses

11,000

Lease Expenses

4,000

Operating profit*

\)18,000

Less: Interest expenses

3,000

Earning before taxes

\(15,000

Less: Taxes (30%)

4,500

Earning after taxes

\)10,500

*equal income before interest and taxes

A-Rod Fishing Supplies had sales of \(2,500,000 and cost of goods sold of \)1,710,000. Selling and administrative expenses represented 10 percent of sales. Depreciation was 6 percent of the total assets of $4,680,000. What was the firm鈥檚 operating profit?
See all solutions

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