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.
The difference between the inventory used for internal reporting purposes and LIFO is referred to
File name: E8-21 In a nutshell.docx File type: .doc PRICE: $5
