Question

EKG Corp. uses the LIFO method for accounting for inventory. Its LIFO inventory balance on December 31, 2014 is $65,000. COGS under LIFO during 2014 was $50,000. EKG Corp. further discloses in the notes of its 2014 annual report that the inventory balance on December 31, 2014 would have been $90,000 if the company used the FIFO method.

1. (6 points) As of the end of December 31, 2014, how much had EKG reduced its income taxes over the life of its operations by using LIFO instead of FIFO? Assume a constant tax rate of 30%.

Answer 1

LIFO
Balance on 31st December 2014 -LIFO	65,000
COGS	50,000
FIFO
Balance on 31st December 2014 -FIFO	90,000
Tax rate	30%
We know that
Cost of goods sold          =	Opening Inventory +Purchases-Closing inventory
LIFO
50000                                   =	Opening Inventory +Purchases-65000
Opening Inventory +Purchases =	1,15,000
Computation of Cost of goods sold under FIFO
Cost of goods sold          =	Opening Inventory +Purchases-Closing inventory
Cost of goods sold          =	115000-90000
Cost of goods sold          =	25,000
LIFO considers the cost under inflated rate .Hence the cost of goods sold under LIFO is higher than FIFO
So the Business enjoys the higher Expense deduction in Income tax under LIFO Method
Reduction of Income tax by using LIFO =	(Cost of goods sold under LIFO-Cost of goods sold under FIFO)*Tax rate
=	(50000-25000)*30%
Reduction of Income tax by using LIFO =	$7,500