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

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.

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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Increase in accounts receivable	Decrease in prepaid expenses
Increase in notes payable	Increase in inventory
Depreciation expense	Dividend payment
Increase in investment	Increase in accrued expenses
Decrease in account payable

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

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

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

Step by step solution

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

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

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Most popular questions from this chapter

Recommended explanations on Business Studies Textbooks

Organizational Communication

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Introduction to Business

Study anywhere. Anytime. Across all devices.

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

Step by step solution

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

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

One App. One Place for Learning.

Most popular questions from this chapter

Recommended explanations on Business Studies Textbooks

Organizational Communication

Business Operations

Corporate Finance

Operational Management

Strategic Analysis

Introduction to Business

Study anywhere. Anytime. Across all devices.

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