E8-21 (LIFO
Effect) The following example was provided to encourage the use of the
LIFO method.
E8-21 In a nutshell, LIFO
subtracts inflation from inventory costs, deducts it from taxable income, and
records it in a LIFO reserve account on the books. The LIFO benefit grows as
inflation widens the gap between current-year and past-year (minus inflation)
inventory costs. This gap is:
|
With LIFO
|
Without LIFO
|
|
|
Revenues
|
$3,200,000
|
$3,200,000
|
|
Cost of goods sold
|
2,800,000
|
2,800,000
|
|
Operating expenses
|
150,000
|
150,000
|
|
Operating income
|
250,000
|
250,000
|
|
LIFO adjustment
|
40,000
|
0
|
|
Taxable income
|
$ 210,000
|
$ 250,000
|
|
Income taxes @ 36%
|
$ 75,600
|
$ 90,000
|
|
Cash flow
|
$ 174,400
|
$ 160,000
|
|
Extra cash
|
$ 14,400
|
0
|
|
Increased cash flow
|
9%
|
0%
|
Instructions
(a)Explain what is
meant by the LIFO reserve account.
(b)How does LIFO
subtract inflation from inventory costs?
(c)Explain how the
cash flow of $174,400 in this example was computed. Explain why this amount may
not be correct.
(d)Why does a company
that uses LIFO have extra cash? Explain whether this situation will always
exist.
TUTORIAL PREVIEW
The difference between the inventory used for
internal reporting purposes and LIFO
File name: E8-21 In a
nutshell.docx File type: .docx PRICE:6
