Globetrade is a retailer that buys virtually all of its merchandise from manufacturers in a country experiencing significant inflation.Globetrade is considering changing its method of inventory costing from first-in,first-out(FIFO)to last-in,first-out(LIFO).
What effect would the change from FIFO to LIFO have on Globetrade’s current ratio and inventory turnover ratio?
A.Both the current ratio and the inventory turnover ratio would decrease.
B.The current ratio would decrease but the inventory turnover ratio would increase.
C.Both the current ratio and the inventory turnover ratio would increase.
D.The current ratio would increase but the inventory turnover ratio would decrease.
Answer(A)is incorrect.The inventory turnover would increase due to higher cost of goods sold and lower inventory.
Answer(B)is correct.During periods of high inflation,manufacturers and retailers often switch to LIFO inventory valuation as a tax postponement tool.
The higher costs attaching to more recent inventory pass into cost of goods sold,reducing net income and tax liability.Since cost of goods sold is the numerator of the inventory turnover ratio,turnover will increase.Also,inventory will be lower under LIFO,which reduces the current ratio and increases the turnover ratio.
Answer(C)is incorrect.The current ratio would decrease due to the lower inventory value under LIFO.
Answer(D)is incorrect.The current ratio would decrease due to the lower inventory value under LIFO.