Selected financial data from Krandall, Inc.’s financial statements for the year ended December 31 was as follows (in $): Cash $100,000 Accounts Payable $400,000 Accounts Receivable 300,000 Deferred Tax Liability 700,000 Inventory 2,400,000 Long-term Debt 8,200,000 Property, Plant & Eq. 9,000,000 Common Stock 1,000,000 Total Assets 11,800,000 Retained Earnings 1,500,000 LIFO Reserve at Jan. 1 600,000 Total Liabilities & Equity 11,800,000 LIFO Reserve at Dec. 31 900,000 Krandall uses the last in, first out (LIFO) inventory cost flow assumption. The tax rate is 40 percent. If Krandall changed from LIFO to first in, first out (FIFO), the assets-to-equity ratio would: A) increase from 4.72 to 5.08. B) decrease from 4.72 to 4.18. C) decrease from 4.72 to 3.74. D) decrease from 4.72 to 4.54. Your answer: C was incorrect. The correct answer was B) decrease from 4.72 to 4.18. Assets-to-equity under LIFO is ($11,800,000 / $2,500,000 =) 4.72. With a change from LIFO to FIFO inventory would increase by the amount of the ending LIFO reserve, so total assets under FIFO would be ($11,800,000 + $900,000 =) $12,700,000. Retained earnings would increase by (ending LIFO reserve * (1 – tax rate)) = ($900,000 (1 – 0.40) =) $540,000. The assets-to-equity ratio under FIFO is ($12,700,000 / ($1,000,000 + $1,500,000 + $540,000) =) 4.18. *****I understand everything except how the intergrity of A=L+E is maintained. If Assets increase 900k and R/E increases 450k, which liability account increases 450k?**** Thanks, dea
Long Term Deferred Tax Liability
Thanks ymc!
Are you sure retained earning calcuation is correct. It should use COGS difference which is 300,000 instead of 900,000.
I tend to agree with disptra too. the denominator - equity calc. does not take the delta of COGS. Since, COGS_fifo = COGS_lifo - (LIFO Reserve_ending - LIFO Reserve_begin) Hence COGS_fifo has a net less cost of = 900,000 - 600,000 = 300,000. Due to this tax saving is : 300,000 * (1 - 0.4) = 180,000. This gets added to equity. Thus equity is: 2,500,000 + 180,000 = 2,680,000 and Assets/Equity = (11,800,000 + 900,000) / ( 2,500,000 + 180,000) = 4.73 Can anyone clarify this?
Hi Just to add to on. For dea, the liability account should not be 450K but 360K. I.e Dr Tax Expense 360K, Cr Deferred Tax Liability 360K. Think you mistakenly typed 540K as 450K and as such thought the tax expense is 900K-450K. As for cfafsa, you are not totally wrong in your last thread but you have to note that the beginning LIFO reserve has to tie to the liabilities and equities side and this 600K is Cr into retained earnings and DTL accordingly based on 40% tax rate. As such the adjusted FIFO accounts should look like below Current Assets Cash 100K AR 300K Inv(FIFO adj) 3,300K Non Current Assets PPE 9,000K Total 12,700K Liability Accounts Payable 400K DTL 1,060K LTD 8,200K Equity Common Stock 1,000K Retained Earn 2,040K Total 12,700K
Thanks EngAudListCo_Director. Your explaination is very lucid. I simply added the increase to the Equity and not the begining balance to adjust the R/E then. I further have a question for clarification. If a company goes from a LIFO to FIFO in accounting statements, the DTL balance increases assuming all other things are equal. It seems logical this happens as FIFO tax expense increases and hence this has to be compensated by a increase in deferred expense (in case a liability) since tax payable is the same.
Hi Director, I still can’t see why it is wrong to add only the increase to R/E. In another word, why do we need to adjust the beginning R/E balance? Is it like a change in accounting policy so we have to restate R/E at the beginning? Thank you
cfafsa Wrote: ------------------------------------------------------- > Thanks EngAudListCo_Director. Your explaination is > very lucid. I simply added the increase to the > Equity and not the begining balance to adjust the > R/E then. I further have a question for > clarification. > > If a company goes from a LIFO to FIFO in > accounting statements, the DTL balance increases > assuming all other things are equal. It seems > logical this happens as FIFO tax expense increases > and hence this has to be compensated by a increase > in deferred expense (in case a liability) since > tax payable is the same. ----actually, firms that uses LIFO for tax purposes is REQUIRED by law to use LIFO for reporting as well, so if they switch from LIFO to FIFO for reporting, the same must be done for tax as well (cos LIFO for tax and FIFO for reporting is not allowed), so this point about DTL will be moot because you can’t have FIFO for reporting and LIFO for tax to create the difference between taxable income and pretax income…however, you can use FIFO for tax and LIFO for reporting, in which case a DTA will be created this is in the CFAI text, V3, p493, under analysis of deferred income tax expense, the piece on inventory