Question

7-72 LIFO, FIFO, Purchase Decisions, and Earnings per Share Kansas Seed Corn Supplies, a company with 100,000 shares of common stock outstanding, had the following transactions during 20X1, its first year in business: Sales Purchases 1,000,000 pounds @ $5 900,000 pounds @ $2 300,000 pounds @ $3 The current income tax rate is a flat 40%; the rate next year is expected to be 35%. It is December 20 and Brian Fleming, the president, is trying to decide whether to buy the 400,000 pounds he needs for inventory now or early next year. The current price is $4 per unit. Prices on inventory are expected to remain stable; in any event, no decline in prices is anticipated. Fleming has not chosen an inventory method as of yet, but will pick either LIFO or FIFO. Other expenses for the year will be $1.4 million. 1. Using LIFO, prepare a comparative income statement assuming the 400,000 pounds (a) are not purchased, and (b) are purchased. The statement should end with reported earnings per share. 2. Repeat requirement 1, using FIFO. 3. Comment on the preceding results. Which method should Fleming choose? Why? Be specific. 4. Suppose that in year 2 the tax rate drops to 35%, prices remain stable, 1.1 million pounds are sold @ $5, enough pounds are purchased at $4 so the ending inventory will be 800,000 pounds, and other expenses are reduced to $800,000. a. Prepare a comparative income statement for the second year showing the impact of each of the four alternatives in year one (LIFO and FIFO with and without the late purchase) on net income and earnings per share for the second year. b. Explain any differences in net income that you encounter among the four alternatives. c. Why is there a difference in ending inventory values under LIFO, even though the same amount of physical inventory is in stock? d. What is the total cash outflow for income taxes for the 2 years together under the four alternatives? e. Would you change your answer in requirement 3 now that you have completed require- ment 4? Why?

Answer 1

1- Using LIFO

	A(Purchased)	B(Not Purchased)
Purchase 300000 @2/700000 @2	$600,000.00	$1,400,000.00
Purchase 300000 @3	$900,000.00	$900,000.00
Purchase 400000 @4	$1,600,000.00	0
COGS	$3,100,000.00	$2,300,000.00
Closing Stock 600000@2/200000@2	$1,200,000.00	$400,000.00

	A(Purchased)	B(Not Purchased)
Sales	$5,000,000.00	$5,000,000.00
Cost of Goods Sold	$3,100,000.00	$2,300,000.00
Gross Income	$1,900,000.00	$2,700,000.00
Other Expense	$1,400,000.00	$1,400,000.00
Income Before Tax	$500,000.00	$1,300,000.00
Less: Tax	$200,000.00	$520,000.00
Income After Tax	$300,000.00	$780,000.00
No. of Share	100000	100000
Earning per Share	$3.00	$7.80

2- Using FIFO

	A(Purchased)	B(Not Purchased)
Sales	$5,000,000.00	$5,000,000.00
Cost of Goods Sold	$2,100,000.00	$2,100,000.00
Gross Income	$2,900,000.00	$2,900,000.00
Other Expense	$1,400,000.00	$1,400,000.00
Income Before Tax	$1,500,000.00	$1,500,000.00
Less: Tax	$600,000.00	$600,000.00
Income After Tax	$900,000.00	$900,000.00
No. of Share	100000	100000
Earning per Share	$9.00	$9.00

3-

EPS	A(Purchased)	B(Not Purchased)
LIFO	$3.00	$7.80
FIFO	$9.00	$9.00

3- Under FIFO method EPS is more than LIFO whether it purchases additional inventory or not, Hence FIFO Method should be accepted.

4- a)

A- If Additional late Purchase Made

	LIFO	FIFO
Sales	$5,500,000.00	$5,500,000.00
Cost of Goods Sold	$4,400,000.00	$3,800,000.00
Gross Income	$1,100,000.00	$1,700,000.00
Other Expense	$1,400,000.00	$1,400,000.00
Income Before Tax	-$300,000.00	$300,000.00
Less: Tax	-$300,000.00	$105,000.00
Income After Tax	-$300,000.00	$195,000.00
No. of Share	100000	100000
Earning per Share	-$3.00	$1.95

b- If Late Purchase not made-

	LIFO	FIFO
Sales	$5,500,000.00	$5,500,000.00
Cost of Goods Sold	$4,000,000.00	$4,200,000.00
Gross Income	$1,500,000.00	$1,300,000.00
Other Expense	$1,400,000.00	$1,400,000.00
Income Before Tax	$100,000.00	-$100,000.00
Less: Tax	$35,000.00	$0.00
Income After Tax	$65,000.00	-$100,000.00
No. of Share	100000	100000
Earning per Share	$0.65	-$1.00

Difference in Profit under above situation is due to method of Inventory applied because Purchase price is high for latest purchase and low for earlier purchase.

.Inventory Values are different under both method because under FIFO method Cost of inventory is more because it has purchased later at high price.