Reading 21:Inventories: Implications for Financial Statement method, center, reserve, statements, 2011

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Session 5: Financial Reporting and Analysis: Inventories and Long-lived Assets
Reading 21: Inventories: Implications for Financial Statements and Ratios

LOS b: Discuss LIFO reserve and LIFO liquidation and their effects on financial statements and ratios.

 

 

Brigham Corporation uses the last-in, first-out (LIFO) method of accounting for inventory.  For the year 2005, the following is provided:

• Cost of goods sold (COGS): $24,000
• Beginning inventory: $6,000
• Ending inventory: $7,500
• The notes accompanying the financial statements indicate that the LIFO reserve at the beginning of the year was $2,250 and at the end of the year was $6,000

 

If Brigham had used first-in, first-out (FIFO), the COGS for 2005 would be:

A) $3,750.

B) $29,250.

C) $20,250.

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FIFO COGS = LIFO COGS ? change in LIFO reserve. Therefore, $24,000 ? ($6,000 ? 2,250) = $20,250.

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GR Corporation uses the last-in, first out (LIFO) method of accounting for inventory and $70,000 is reported as cost of goods sold (COGS) on their income statement. However, if GR had used first-in, first-out (FIFO), the COGS would have been $60,000. If the ending LIFO reserve (LR) reported in the financial statements is $40,000, the beginning LIFO reserve is:

A) $30,000.

B) $50,000.

C) $20,000.

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Beginning LR + ΔLR = Ending LR> >

ΔLR = COGS(LIFO) – COGS(FIFO) = $70,000 – 60,000 = $10,000> >

Beginning LR = $40,000 – 10,000 = $30,000> >

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An analyst gathers the following information about a firm:

• Last in, first out (LIFO) inventory = $10,000
• Beginning LIFO reserve = $2,500
• Ending LIFO reserve = $4,000
• LIFO cost of goods sold = $15,000
• LIFO net income = $1,500
• Tax rate is 40%

To convert the financial statements to a FIFO basis, the amount the analyst should add to the stockholders' equity is closest to:

A) $2,800.

B) $2,400.

C) $4,000.

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If the firm had used FIFO inventory cost, tax liability would be higher by (LIFO reserve × tax rate) and retained earnings would be higher by [LIFO reserve × (1 ? tax rate)].

(LIFO reserve)(1 ? t) = $4,000(1 ? 0.4) = $2,400

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The Baker Company uses the last in, first out (LIFO) inventory valuation method and reported its inventory at $200,000 and its cost of goods sold (COGS) at $500,000. The company’s LIFO reserve increased from $5,000 to $30,000 during the year. What amounts would the company report for ending inventory and cost of goods sold if it were to use the first in, first out (FIFO) method?

Ending Inventory

COGS

A) $230,000 $475,000

B) $230,000 $525,000

C) $170,000 $525,000

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Ending inventory under FIFO is equal to LIFO ending inventory + LIFO reserve

= 200,000 + 30,000 = 230,000

COGS under FIFO equals LIFO COGS ? (ending LIFO reserve ? beginning LIFO reserve)

= 500,000 ? (30,000 ? 5,000) = 475,000.

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Which of the following is least likely to happen after a last in, first out (LIFO) liquidation in an environment of rising prices?

A) Increase gross income.

B) Increase taxable income.

C) Increase cost of goods sold (COGS).

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In a LIFO liquidation, a firm allows inventory to decrease so that it is using lower-cost materials (purchased in the past). This will lower the COGS and increase income and profit. This is one of the ways that a firm’s management can manipulate earnings.

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Under last in first out (LIFO) accounting during periods of inflation, when a firm sells a greater quantity of its inventory than it produces or acquires, the result is:

A) an increase in the LIFO reserve.

B) an understatement of the cost of goods sold (COGS).

C) lower earnings.

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This is a LIFO liquidation which refers to a declining inventory balance (the units available for sale are declining). In this case the prices for goods that are being sold are no longer recent prices and can be many years out of date.  This would make COGS appear to be very low and gross and net profits to be artificially high.

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First in, first out (FIFO) inventory equals:

A) LIFO cost of goods sold ? changes in LIFO reserve.

B) the change in LIFO reserve ? LIFO ending reserve.

C) LIFO inventory + LIFO reserve.

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To convert LIFO inventory balances to a FIFO basis, simply add the LIFO reserve to the LIFO inventory:

INV_F = INV_L + LIFO Reserve

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Given the following data:

• Beginning LIFO Reserve $2,300
• Cost of Goods Sold (COGS) using LIFO $6,100
• COGS using FIFO of $4,300

What is the Ending LIFO reserve?

A) $500.

B) $2,800.

C) $4,100.

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Ending LIFO Reserve = (LIFO COGS ? FIFO COGS) + Beginning LIFO Reserve = (6,100 ? 4,300) + 2,300 = $4,100.

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The following information has been gathered about a firm:

• LIFO inventory = $10,000
• Beginning LIFO reserve = $2,500
• Ending LIFO reserve = $4,000
• LIFO cost of goods sold = $15,000
• LIFO net income = $1,500
• Tax rate is 40%

What is the FIFO COGS?

A) $16,500.

B) $11,000.

C) $13,500.

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FIFO COGS = LIFO COGS – change in LIFO reserve

= $15,000 – (4,000 ? 2,500) = $13,500

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The formula to convert an ending inventory value from the LIFO to the FIFO method is to:

A) FIFO inventory = LIFO inventory + LIFO reserve.

B) FIFO inventory = LIFO inventory ? LIFO reserve.

C) FIFO inventory = LIFO inventory × LIFO reserve.

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The formula to convert an ending inventory value from the LIFO to the FIFO method is to FIFO inventory = LIFO inventory + LIFO reserve.