Asked by Ninh Thi Thuy Trang on May 16, 2024
Verified
Tyler Company reported the following summarized annual data at the end of 2016: Sales revenue $1,000,000 Cost of goods sold ∗600,000‾ Gross margin 400,000 Operating expenses 280,000‾ Income before income taxes $120,000\begin{array}{lr}\text { Sales revenue } & \$ 1,000,000 \\\text { Cost of goods sold }{ }^{*} & \underline{ 600,000} \\\text { Gross margin } & 400,000 \\\text { Operating expenses } & \underline{280,000} \\\text { Income before income taxes } & \$ 120,000\end{array} Sales revenue Cost of goods sold ∗ Gross margin Operating expenses Income before income taxes $1,000,000600,000400,000280,000$120,000
"Based on an ending FIFO inventory of $240,000\$ 240,000$240,000 .
The income tax rate is 30%. The controller of the company is considering a switch from FIFO to LIFO. He has determined that on a LIFO basis the ending inventory would have been $150000.
Instructions
(a) Restate the summary information on a LIFO basis.
(b) What effect if any would the proposed change have on Tyler's income tax expense net income and cash flows?
(c) If you were an owner of this business what would your reaction be to this proposed change?
FIFO
An inventory valuation method that assumes goods are sold in the order they are acquired, standing for "First In, First Out."
LIFO
LIFO stands for "Last In, First Out," a method used in inventory management and accounting where the most recently produced items are recorded as sold first.
Income Tax Expense
The cost associated with income taxes due to a government, calculated based on taxable income.
- Analyze the effect of changing inventory valuation methods on tax expenses, net income, and company cash flows.
Verified Answer
BR
Bailey RatliffMay 22, 2024
Final Answer :
(a) Restate to a LIFO basis:
Sales revenue $1,000,000 Cost of goods sold* 690,000‾ Gross margin 310,000 Operating expenses 280,000‾ Income before income taxes $30,000‾\begin{array}{lr}\text { Sales revenue } & \$ 1,000,000 \\\text { Cost of goods sold* } & \underline{ 690,000} \\\text { Gross margin } & 310,000 \\\text { Operating expenses } & \underline{280,000} \\\text { Income before income taxes } & \underline{\$ 30,000}\end{array} Sales revenue Cost of goods sold* Gross margin Operating expenses Income before income taxes $1,000,000690,000310,000280,000$30,000
*Ending inventory would be $90000 less ($240000 - $150000 = $90000) under LIFO thereby increasing cost of goods by $90000.
(b) The taxes on the FIFO basis would be:
$120000 ×.30 = $36000
Leaving Net Income of $84000 ($120000 - $36000 = $84000).
The taxes on the LIFO basis would be:
$30000 ×.30 = $9000
Leaving Net Income of $21000 ($30000 - $9000 = $21000).
Switching to the LIFO basis will result in $27000 less income tax expense and less net income of $63000. The cash effect is $28000 ($36000 - $9000 = $27000) saved in taxes if LIFO were used.
(c) Owners of the business may favor the LIFO basis since more cash will be available for use in the business. LIFO results in more cash being retained in the business since less is paid out for income taxes.
Sales revenue $1,000,000 Cost of goods sold* 690,000‾ Gross margin 310,000 Operating expenses 280,000‾ Income before income taxes $30,000‾\begin{array}{lr}\text { Sales revenue } & \$ 1,000,000 \\\text { Cost of goods sold* } & \underline{ 690,000} \\\text { Gross margin } & 310,000 \\\text { Operating expenses } & \underline{280,000} \\\text { Income before income taxes } & \underline{\$ 30,000}\end{array} Sales revenue Cost of goods sold* Gross margin Operating expenses Income before income taxes $1,000,000690,000310,000280,000$30,000
*Ending inventory would be $90000 less ($240000 - $150000 = $90000) under LIFO thereby increasing cost of goods by $90000.
(b) The taxes on the FIFO basis would be:
$120000 ×.30 = $36000
Leaving Net Income of $84000 ($120000 - $36000 = $84000).
The taxes on the LIFO basis would be:
$30000 ×.30 = $9000
Leaving Net Income of $21000 ($30000 - $9000 = $21000).
Switching to the LIFO basis will result in $27000 less income tax expense and less net income of $63000. The cash effect is $28000 ($36000 - $9000 = $27000) saved in taxes if LIFO were used.
(c) Owners of the business may favor the LIFO basis since more cash will be available for use in the business. LIFO results in more cash being retained in the business since less is paid out for income taxes.
Learning Objectives
- Analyze the effect of changing inventory valuation methods on tax expenses, net income, and company cash flows.