ANSWERS TO QUESTIONS
15. When prices are increasing, LIFO results in higher cost of goods sold, and lower income
relative to FIFO. Because LIFO income is lower the company pays lower taxes, which results in
higher cash flows. The quality of earnings ratio is net cash provided by operating activities
divided by income. The use of LIFO will increase the numerator (net cash provided by
operating activities) and decrease the denominator (net income), both of which increase the
value of the ratio.
BRIEF EXERCISE 6-5
Cost of goods sold under:
Purchases
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
*(100 X $6) + (80 X $7)
LIFO
FIFO
$6 X 100
$7 X 200
$8 X 140
$ 3,120
$ 1,160*
$ 1,960
$6 X 100
$7 X 200
$8 X 140
$ 3,120
$ 1,400**
$ 1,720
**(140 X $8) + (40 X $7)
Since the cost of goods sold is $240 ($1,960 – $1,720) less under FIFO that
is the amount of the phantom profit. It is referred to as “phantom profit”
because FIFO matches current selling prices with old inventory costs. To
replace the units sold the company will have to pay the current price of
$8 per unit, rather than the $6 per unit which some of the units were
priced at under FIFO. Therefore, profit under LIFO is more representative
of what the company can expect to earn in future periods.
BRIEF EXERCISE 6-8
Inventory turnover ratio:
Days in inventory:
$349,114
$349,114
=
= 2.54 times
($119,035+ $155,377) ÷ 2 $137,206
365
=144 days
2.54
EXERCISE 6-9
Inventory at
Market
Lower-of-CostLower-of-CostCost/Unit Value/Unit
or-Market
Units
or-Market
Cameras:
Minolta
Canon
Light Meters:
Vivitar
Kodak
Total
$170
145
$158
152
$158
145
5
7
$ 790
1,015
125
120
114
135
114
120
12
10
1,368
1,200
$4,373
EXERCISE 6-10
2007
2008
2009
$18,038
($1,926 +$2,290) ÷ 2
$20,351
($2,290 +$2,522) ÷ 2
$20,099
($2,522+$2,618) ÷2
$18,038
=8.6 times
$2,108
$20,351
=8.5 times
$2,406
$20,099
=7.8 times
$2,570
Days in
inventory
365
=42.4 days
8.6
365
=42.9 days
8.5
365
=46.8 days
7.8
Gross
profit rate
$39,474 – $18,038
=.543
$39,474
$43,251– $20,351
=.529
$43,251
$43,232 – $20,099
=.535
$43,232
Inventory
turnover
ratio
The inventory turnover ratio decreased by approximately 10% from 2007
to 2009 while the days in inventory decreased by a similar amount (10%)
over the same time period. Both of these changes would be considered
unfavorable since it’s better to have a higher inventory turnover ratio with
a corresponding lower days in inventory. PepsiCo., Inc.’s gross profit rate
decreased by 1.5% from 2007 to 2009.