# Doubt in LIFO FIFO conversion

Pls see following question/answer. (Sorry for the unformatted numbers but I am hoping you have done the same question). My doubt is, why will the pretax income be higher than 900k with FIFO? I think FIFO will have lower COGS by the difference of LIFO reserve, (900k-600k = 300k) and hence pretax income should be higher by this amount. Pls help by answering how does pretax income increase by 900k. Thanks in advance! Selected financial data from Krandall, Inc.’s balance sheet for the year ended December 31 was as follows (in \$): Cash \$1,100,000 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. 8,000,000 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 used first in, first out (FIFO) instead of LIFO and paid any additional tax due, its assets-to-equity ratio would be closest to: A) 3.63 B) 4.06 C) 3.73 D) 4.18 Your answer: A was incorrect. The correct answer was B) 4.06 With FIFO instead of LIFO: • Inventory would be higher by \$900,000, the amount of the ending LIFO reserve. • Cumulative pretax income would also be higher by \$900,000, so taxes paid would be higher by 0.40(\$900,000) = \$360,000. Therefore cash would be lower by \$360,000. • Cumulative retained earnings would be higher by (1 - 0.40)(\$900,000) = \$540,000. So assets under FIFO would be \$11,800,000 + \$900,000 - \$360,000 = \$12,340,000 and equity would be \$1,000,000 + \$1,500,000 + \$540,000 = \$3,040,000. The assets-to-equity ratio would be \$12,340,000/\$3,040,000 = 4.06.

The explanation makes it pretty clear. I wish you had waited to post the explanation before other people had read it.

Exactly because the COGS is lower by 900,000, an ammout with 900,000 smaller would have been deducted from Sales as COGS, hence Pretax income 900,000 higher.

FIFO Inventory = LIFO inventory plus entire LIFO reserve, not what changed beginning to the end of the year. When calculating the ending or beginning balance of the inventory in FIFO you should use the increased/decreased amount of LIFO reserve over the year, adding the difference to the FIFO beginning.

however, COGS (F) = COGS(L) - Ending lifo reserve + beginning Lifo reserve

<> map1, How is COGS lower by 900,000? Shouldn’t it be lower by 300,000, because LIFO Reserve at Jan. 1 = 600,000 and LIFO Reserve at Dec. 31= 900,000. Unless I am missing something, isn’t FIFO COGS = LIFO COGS - increase in LIFO reserve?

My guess is that they are looking for the difference between LIFO and FIFO since the inception of the firm. The \$900,000 LIFO reserve at the end of the year represents the cumulitive change in LIFO since inception, that also represents the total amount of income that was deferred for tax purposes. My .02 dollars.

If they are looking for the difference between LIFO and FIFO for the SPECIFIC year then FIFO COGS = COGS LIFO - (LIFO reserve (end) - LIFO reserve (beg))

map1 Wrote: ------------------------------------------------------- > Exactly because the COGS is lower by 900,000, an > ammout with 900,000 smaller would have been > deducted from Sales as COGS, hence Pretax income > 900,000 higher. COGS is lower by 300

hmmmm…you’re right.

map1 Wrote: ------------------------------------------------------- > hmmmm…you’re right. Thanks, looks like the answer is wrong, they should have increased the pretax income by 300k instead of 900k.

I bet they are looking for the inventory restatement for the beginning of the company, not for the specific year effect. That is why the entire reserve gets added to pretax income.

The conversion of LIFO to FIFO from the beginning of the company would alocate the entire reserve as: LIFO Reserve (1-tax rate) as adjustment to retained earnings LIFO Reserve * tax rate as adjustment to deferred taxes

Yes, however the question didn’t word that clearly, which mislead a lot of people.

Not saying that it refers to this year strictly either, but you know it should have been converted back to the beginnings to have a meaningfull comparison. Cannot mix and match FIFO this year based on LIFO results last year, it has to be FIFO from the beginnings.