Question

Minitax Corporation accounts for 100% of its inventory using LIFO. In its most recent annual report, Minitax reported the following information on the Balance Sheet.

                                                                        Dec. 31                Dec. 31      

                                                                           2018                  2017

                        Inventory                           $ 65,000,000      $ 70,000,000              

Minitax's Inventory Footnote appeared as follows:

"The Company uses LIFO to account for all inventory. Inventories valued on the LIFO basis at December 31, 2018 and 2017 were approximately $ 25,000,000 and $ 30,000,000, respectively, less than the amounts of such inventories valued at current costs.

As a result of the reduction in quantity of certain inventories, profits from liquidation of inventories were recorded which increased pre-tax net income by $ 10,000,000 and $ 5,000,000 in 2018 and 2017, respectively."         

Assume that Minitax pays corporate income tax at a rate of 40%. Further, assume that the balance of inventory calculated using FIFO is equal to the inventory's current cost.

A. If Minitax used FIFO, what inventory would they have reported on their Balance Sheet as of December 31, 2018?

B. What would the "LIFO Reserve" have been on December 31, 2018 if no LIFO liquidation had occurred in 2018?

C. What is the cumulative amount of tax savings that Minitax has realized as of December 31, 2018 as a result of using LIFO instead of FIFO?

Answer 1

On account of following LIFO instead of FIFO, the closing inventory has been valued at lower cost. So, had FIFO been followed inventory would be same as current costs. INVENTORY VALUE UNDER FIFO:- As on 31st Dec 2017 - $ 70,000,000 + $ 30,000,000 = $ 1,000,000,000 The value as on 31st Dec 2017 increased by $ 30,000,000 and similarly value as on 31st Dec 2018 would have increased by $ 30,000,000 effect of 2017 and $ 25,000,000 As on 31st Dec 2018 - $ 65,000,000 + $ 25,000,000 + $ 30,000,000 = $ 1,200,000,000 LIFO Reserve on 31st Dec would be cumulative effect of year 2017 and year 2018. LIFO RESERVE as on 31st Dec 2018 = $5,000,000+ $10,000,000 = $ 15,000,000 Amount of tax saved by Minitax:- Lower valuation of Inventory by = $1,200,000,000 - $ 65,000,000 = $ 55,000,000 LIFO reserve = $ 15,000,000 Value saved by company = $ 55,000,000 - $ 15,000,000 Value saved by company = $ 40,000,000 Tax % applicable to the company = 40% CUMULATIVE TAX SAVINGS = $ 40,000,000 * 40% CUMULATIVE TAX SAVINGS = $ 16,000,000