When calculating the new current ratio under FIFO as opposed to LIFO, why does the solution show only the LIFO Reserve being added to current assets? Isn’t the net effect on current assets equal to the LIFO Reserve * (1-tax rate) due to a decrease in cash used to pay taxes on the reserve? The tax rate wasn’t provided so I backed out of it only to find that I wasted my time…what am I missing here?
You add the Lifo Reserve to the inventory. Not necessarily to Current Assets, even though since inventory is part of the CA, it would be the same.
The way I remember it is if you adjust any line item above where taxes normally are (e.g. ebit and above) then you don’t need to take taxes into account.
However, if you are adjusting anything below where taxes are taken out (e.g. NI or Retained Earnings) then you have to incude the (1-T).
With this logic,inventory relates to COGS which is above the taxable line, so no (1-T) is needed.
It was probably an error not to state that it was tax deferred. but who knows.
I see what your’e saying…I just thought since they were asking for the current ratio which includes all current assets, (as opposed to the quick ratio which would exclude cash altogether) I needed to adjust for cash as well. Either way the answer was the same. in this particular case anyway.
I still think it’s an error not to include tax because if FIFO is being used, higher tax will be charged, resulting in less cash.
Book page 18, it subtracted the tax of 898, which is due to the higher tax caused by higher EBIT