Study Appendix 16A. Home Depot, one of the five largest retailers in the United States, uses the FIFO inventory method. On January 29, 2012, the company reported merchandise inventory of $10.3 billion.

At the beginning of the fiscal year, the inventory amount was $10.6 billion. Cost of merchandise sold for fiscal 2012 (the year ended January, 2012) was $46.1 billion, and operating income was $6.7 billion.

During the year, Home Depot purchased merchandise for $45.8 billion. Suppose Home Depot had changed to LIFO on the first day of fiscal 2012, using the current inventory amount ($10.6 billion) as the first LIFO layer. Assume that its LIFO inventory on February 1, 2012, was $9.8 billion instead of the FIFO value of $10.3 billion.

1. Compute Home Depot’s cost of merchandise sold and operating income for the year ended February 1, 2012, assuming that the switch to LIFO had been made at the beginning of fiscal 2012.

2. How would the switch to LIFO have affected Home Depot’s fiscal 2012 income taxes, assuming a 40% tax rate? Assume that Home Depot switches to LIFO for both financial reporting and tax purposes.

3. Were the prices Home Depot paid for merchandise inventory rising or falling during fiscal 2012? How do you know?