LIFO Reserve Qbank question 400, 900, understand, question, increase

luda002

Can someone explain how they are using 900,000 LIFO reserve to calculate an increase in income? I understand how this will increase assets (inventory) but I do not see the correlation with increased income.
Selected financial data from Krandall, Inc.’s balance sheet for the year ended December 31 was as follows (in $):
Cash
$1,100,000
Accounts Receivable
300,000
Inventory
2,400,000
Property, Plant & Eq.
8,000,000
Common Stock
1,000,000
Total Assets
11,800,000
LIFO Reserve at Jan. 1
600,000
LIFO Reserve at Dec. 31
900,000
Accounts Payable
$400,000
Deferred Tax Liability
700,000
Longterm Debt
8,200,000
Retained Earnings
1,500,000
Total Liabilities & Equity
11,800,000
Krandall uses the last in, first out (LIFO) inventory cost flow assumption. The tax rate is 40%. If Krandall used first in, first out (FIFO) instead of LIFO and paid any additional tax due, its assetstoequity ratio would be closest to:
A) 4.06
B) 3.73
C) 4.18
Your answer: C was incorrect. The correct answer was A) 4.06
With FIFO instead of LIFO:
Inventory would be higher by $900,000, the amount of the ending LIFO reserve.
Cumulative pretax income would also be higher by $900,000, so taxes paid would be higher by 0.40($900,000) = $360,000. Therefore cash would be lower by $360,000.
Cumulative retained earnings would be higher by (1 ? 0.40)($900,000) = $540,000.
So assets under FIFO would be $11,800,000 + $900,000  $360,000 = $12,340,000 and equity would be $1,000,000 + $1,500,000 + $540,000 = $3,040,000. The assetstoequity ratio would be $12,340,000 / $3,040,000 = 4.06.

needhelp1700

Remember this equation ; A = L + E
So when asset (Inventory ) increased by $900,000 then L & E are to be increased by [900,000*0.4] i.e, Deferred Tax Liab and [900,000*10.4] retained earnings respectively. But in this case the trick is that the addtional tax due was paid hence there will be no deferred tax liability created.
Again note that the tax was paid out of cash (asset) and that is why total asset decreased by LIFO Reserve*tax rate .
You mentioned increased income. Of course, net income is affected when you are converting from LIFO to FIFO. Here’s how net income is affected:
FIFO Net Income = LIFO Net income + Change in LIFO Reserve*(1t).
Hope this helps to clear things a bit.