Question

The following information pertains to CVS which uses LIFO to compute the value of inventories. Inventory values computed under the two methods are given below. End of year End Iny - LIFO End Inv - FIFO Income before taxes - LIFO 2004 2,257.0 3,040.7 1,000.7 2005 2,202.9 3,166.6 1,174.0 2006 2,354.4 3,515.2 1,627.5

1-From 2005 to 2006, did input prices rise, fall or remain unchanged?

2-From inception till the end of 2006 (i.e., over the life of the company), how much has the company saved or lost in taxes by using LIFO? Assume a tax rate of 40%.

Answer 1

Answer 1 : As from 2005-2006 end inventory as per LIFO (last in first out) and as per FIFO (First in first out) are more in FIFO method means Price of input is less in earlier years because of which ending inventory value in FIFO method is more and inventory value under LIFO method is less.

As In LIFO inventory is valued at purchase price on earlier units as latest units are sold first, and in FIFO units which come first goes out first because of which inventory is valued at units which comes at last.

Answer 2 : As under LIFO method ending inventory value is less i.e. closing inventory is valued at less price its leads to decrease in profit chargeable to tax as cost of goods sold in LIFO method is more.

Tax saved due to LIFO method is 1163.28.

End of year	LIFO	FIFO	Difference
2004	2257	3040.7	783.7
2005	2202.9	3166.6	963.7
2006	2354.4	3515.2	1160.8
Total			2908.2
Tax rate			40%
Tax saving			1163.28