Question

CA8.11  

(LO 3, 4 ) (LIFO Choices) Wilkens Company uses the LIFO method for inventory costing. In an effort to lower net income, company president Mike Wilkens tells the plant accountant to take the unusual step of recommending to the purchasing department a large purchase of inventory at year-end. The price of the item to be purchased has nearly doubled during the year, and the item represents a major portion of inventory value.

Also answer the following:       -what ratios are likely affected by this purchase?

What are the incremental benefits that must be compared to the incremental consequences?  

What amount should be purchased at a maximum?

What amount should be purchased at a minimum?

Answer 1

The following ratios are likely to be affected by this purchase as inventory is part of current assets in Balance sheet

· Current ratio (Current assets/Current liabilities)

· Inventory turnover ratio – (Cost of goods sold /Average inventory)

· Inventory Average days on hand ( 365 days/ Inventory turnover ratio)

The incremental benefits are cost savings due to price increase. The sooner the inventory is purchased the higher is the cost savings for the differential pricing of increase expected in purchase price. The incremental cost is the cost of working capital in terms of financing the inventory and the cost of holding inventory like storage cost

The maximum amount of inventory to be purchased depends on the extent of working capital financing availability and the storage capacity availability for the inventory

The minimum amount of inventory to be purchased is equal to the safety stock plus the additional stock needed for the production plan to be met.