Fraser Corporation uses the LIFO method of inventory valuation and is preparing its financial statements for the
Question:
Fraser Corporation uses the LIFO method of inventory valuation and is preparing its financial statements for the year 2008. Its controller provided the following income statement for the year ended December 31, 2008 to top management for review:
Fraser’s CEO had mixed emotions after examining the income statement. He wanted to know how Fraser compares with its closest rival, KAS Corporation, and he instructed the controller to “compute some ratios for both companies.” KAS uses the FIFO method of inventory valuation.
The following are excerpts from the controller's report:
Required:
1. Complete the controller’s report by computing the ratios for Fraser based on the information given in the preceding income statement. For each ratio, how does Fraser compare with KAS? Explain how the choice of inventory methods biases the comparisons in favor of either Fraser or KAS.
2. After reviewing the controller’s report, the CEO was concerned about Fraser's performance relative to KAS on two of the three ratios. However, the controller pointed out to the CEO that Fraser’s “perceived underperformance” is primarily driven by differences in accounting methods. In addition, the controller added that if one takes into account “our current period LIFO tax savings, Fraser has outperformed KAS.’ The CEO asked the controller, “Why don’t you show me how an analyst might adjust our income statement to make it comparable to that of KAS?” Your task is to help the controller by preparing a pro forma income statement for Fraser that is comparable to that of KAS. Assume that if Fraser had used the FIFO method, the beginning and ending inventories would have been higher by $50,000 and $150,000, respectively. On the basis of the “adjusted” income statement, Recompute the three ratios given in the controller’s report, and explain how and why the revised figures alter the CEO’s earlier conclusions.
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