Question

PROBLEM 3:25 POINTS Tyler Company reported the following summarized annual data at the end of 2020: Sales revenue $1,000,000 Cost of goods sold" 600.000 Gross margin 400,000 Operating expenses 280.000 Income before income taxes $ 120.000 "Based on an ending FIFO inventory of $240,000. The income tax rate is 30%. The controller of the company is considering a switch from FIFO to LIFO. He has determined that on a LIFO basis, the ending inventory would have been $150,000. Instructions (a) Restate the summary information on a LIFO basis. (b) What effect, if any, would the proposed change have on Tyler's income tax expense, net income, and cash flows? (c) If you were an owner of this business, what would your reaction be to this proposed change?

Answer 1

1. Calculation of cost of goods sold under LIFO method,
   1. Usually cost of goods sold is calculated by using the formula opening + purchases - closing stock here in the place of closing stock we should substitute 150000 instead of 240000 then the outcome would be as follows,
   2. Add 240000 and deduct 150000 implies excess addition of 90000(240000-150000).
   3. Therefore cost of goods sold will become 600000 + 90000 = 690000.
2. Summary under LIFO method,

3. Sales revenue	1,000,000
   Cost of goods sold	690,000
   Gross margin	310,000
   Operating expenses	280,000
   Income before income taxes	30,000

   Net income under LIFO is 30,000

1. Effects,
   1. On income tax expense,
      1. As the value of closing inventory is reduced under LIFO method, it will lead to decrease in net income resulting is lower income tax expense than under FIFO method, therefore income tax expense will decrease.
      2. Amount of decrease will be 120000 - 30000 * 30% = 27,000.
   2. On net income,
      1. As already explained above net income will decrease by 90,000.
   3. Cash flows,
      1. There won't be any effect on the cash flows of the company, as there won't be any flow of cash because of mere changing in the method of valuation. Only the values will change.
2. If I were the owner of business, in would feel happy that the amount of income tax expense reduced, but at the same time i would be concerned about the decrease in net income and also the value of inventory on hand.