Strategies to Improve Debt-to-Equity Ratio

C

The company will use FIFO (assuming prices are increasing) and straight line depreciation to increase income and hence, retained earnings. This improves the debt-to-equity ratio.

The debt-to-equity ratio measures the proportion of a firm's financing that comes from debt compared to equity. A high debt-to-equity ratio indicates that the firm has a significant amount of debt relative to its equity. In order to improve this ratio, the firm would need to decrease its debt or increase its equity.

Accounting methods can have an impact on a firm's financial statements, including the balance sheet, income statement, and cash flow statement. The choice of accounting methods can affect the reported values of assets, liabilities, revenues, and expenses, which can ultimately impact the debt-to-equity ratio.

In the given options, let's analyze each choice:

A. LIFO accounting and accelerated depreciation: LIFO (Last-In, First-Out) is an inventory valuation method where the most recently acquired inventory is assumed to be sold first. This method typically results in higher cost of goods sold (COGS) and lower net income compared to other methods such as FIFO (First-In, First-Out).

Accelerated depreciation refers to using depreciation methods that result in higher depreciation expense in the earlier years of an asset's life and lower depreciation expense in the later years.

Using LIFO accounting and accelerated depreciation can result in lower net income in earlier years, which would decrease retained earnings and potentially decrease equity. Since the firm wants to improve its debt-to-equity ratio, this choice would be preferred.

B. LIFO accounting and straight-line depreciation: As mentioned earlier, LIFO accounting can result in lower net income compared to other inventory valuation methods. However, the choice of straight-line depreciation would result in a consistent depreciation expense over the asset's useful life.

While using LIFO accounting would have a negative impact on net income, the straight-line depreciation method would not have a significant impact on the timing of expenses. Therefore, this choice may not be as effective in improving the debt-to-equity ratio compared to option A.

C. FIFO accounting and straight-line depreciation: FIFO accounting assumes that the oldest inventory is sold first. This method typically results in lower COGS and higher net income compared to LIFO.

Using FIFO accounting would result in higher net income, which could increase retained earnings and potentially increase equity. This choice would not be preferable for improving the debt-to-equity ratio.

D. FIFO accounting and accelerated depreciation: Similar to option C, FIFO accounting would result in higher net income compared to LIFO. However, combining FIFO accounting with accelerated depreciation would result in higher depreciation expense in the earlier years, potentially decreasing net income and retained earnings.

While accelerated depreciation would decrease net income, the use of FIFO accounting may counteract this effect to some extent. Therefore, this choice may not be as effective in improving the debt-to-equity ratio compared to option A.

Based on the analysis, option A (LIFO accounting and accelerated depreciation) would be the preferred choice for a firm with a high debt-to-equity ratio, as it would likely result in lower net income in earlier years, potentially decreasing retained earnings and improving the debt-to-equity ratio.