The following example was provided to encourage the use of the LIFO method. 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 following example was provided to encourage the use of the LIFO method. In a nutshell, LIFO subtracts inflation from inventory costs, deducts it from taxable income, and records it in a LIFO...

The following example was provided to encourage the use of the LIFO method. 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.

Jun 03, 2022

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The following example was provided to encourage the use of the LIFO method. In a nutshell, LIFO subtracts inflation from inventory costs, deducts it from taxable income, and records it in a LIFO...

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