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1. At a recent company meeting, an employee remarks: 'We were working so hard to get the income for our bonus this year. Then they got that entire raw material inventory in and even paid for it. We don't need it yet. Why didn't they wait until January?' Will the raw material inventory affect this year's income? Does it matter whether it was paid for this year or in January? Explain. Give examples to support your answers.

2. Your friend comments, 'I just ignore the income statement when I'm making an investment decision. All I care about is the cash, so that the company can pay me dividends. The balance sheet tells me about the cash the company's got; the cash flow statement tells me about its changes in cash. Who cares about the income statement? It's just a bunch of inaccurate stuff loaded with estimates.'Do you agree with your friend's remarks about the income statement and its lack of importance? Explain why or why not.

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Solution Summary

The solution explains two questions relating to inventory effect to net income and lack of importance of the income statement

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1. The raw material inventory transaction will not affect the income for the year and it does not matter whether it was paid or not. The purchase of inventory is a balance sheet transaction. When inventory is purchased, it will show up as inventory in the balance sheet and accounts payable in the balance sheet if it is not paid for. When it is paid, cash and accounts payable will change in the balance sheet. Inventory affects the income statement on sale when it is shown as cost of goods sold for the ...

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