In August 1990, Iraq invaded Kuwait. For gasoline distributors, this meant that the price they paid for oil in the future could increase dramatically. For consumers, the effect was more immediate. Within a week, gasoline prices had jumped by as much as 20 cents per gallon. The American public accused gasoline distributors of ripping off consumers by raising the price on gas that was purchased prior to the Gulf crisis. Distributors countered by stating that it is replacement cost, not historical cost that dictates selling price.
1. Assuming FIFO costing of inventory, what would be the effect of an increased selling price on the income statement of a gasoline distributor?
2. What would be the effect on the distributor’s statement of cash flows as the firm replaced the inventory with more expensive petroleum products?
3. Was the American public correct in claiming that gasoline distributors used the Gulf crisis as an opportunity to increase profits?