ACCOUNTING ALTERNATIVES AND FINANCIAL ANALYSIS Cheap Auto, Inc., has asked your bank for a $100,000 loan to expand its sales facility.

Cheap Auto provides you with the following data:

2009 2008 2007 Sales revenue $6,900,000 $6,400,000 $6,100,000 Net income 120,000 113,000 109,000 Ending inventory (FIFO)* 675,000 620,000 510,000 Purchases 5,410,000 5,200,000 4,990,000 Depreciable assets 1,320,000 1,230,000 1,120,000

*The 2006 ending inventory was $420,000 (FIFO).

Your inspection of the financial statements of other auto sales firms indicates that most of these firms adopted the LIFO method in the late 1970s. You further note that Cheap Auto has used 10 percent of depreciable asset cost when computing depreciation expense and that other automobile dealers use 20 percent. Assume that Cheap Auto’s effective tax rate is 30 percent of income before tax. Also assume the following:

2009 2008 2007 Ending inventory (LIFO)* $518,000 $512,000 $500,000

*The 2006 ending inventory was $420,000 (LIFO).

Required:

. Compute cost of goods sold for 20072009, using both the FIFO and the LIFO methods.

. Compute depreciation expense for Cheap Auto for 20072009, using both 10 percent and 20 percent of the cost of depreciable assets.

. Recompute Cheap Auto’s net income for 20072009, using LIFO and 20 percent depreciation. (Don’t forget the tax impact of the increases in cost of goods sold and depreciation expense.)

. Does Cheap Auto appear to have materially changed its financial statements by the selection of FIFO (rather than LIFO) and 10 percent (rather than 20 percent)

depreciation?

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