Can someone explain a bit what’s going on? Don’t we decrease the earnings when there is a LIFO liquidation (understate the COGS) Inventories are listed on the balance sheet at $600,000, retained earnings are $1.9 Million. In the notes to financial statements, you find a LIFO reserve of $125,000. Also, the probability of a LIFO liquidation is high. Assuming a tax rate of 36 percent, what will be the adjusted value of retained earnings? A) $1,980,000. B) $1,820,000. C) $1,855,000. D) $1,945,000. The correct answer was A. The adjustment to retained earnings will be: $125,000*(1-.36).
the inventory is understated so you have to adjust it up. the offsetting entry is to RE. you’re thinking of IS adjustments
Man I can’t remember anything from FSA. I do know that if the LIFO liquidation is likely then really low cost COGS are going to be running through the income statement in the near future. This will increase your net income and consequently flow through to retained earnings. I am not sure if the question (and you) are asking the accounting stuff or the real world stuff the analyst is supposed to adjust for. EDIT: This assumes an inflationary environment.
A = L + E A (inventory) increase by 125,000, so depreciation increases (i.e Liabilities) and retained earning from equity increases by LIFOReserve*(1 - TR) = 125000*(1-0.36) = 80000 [A + 125000] = [L + 45000] + [E + 80000]. is this correct???
Slash Wrote: ------------------------------------------------------- > the inventory is understated so you have to adjust > it up. the offsetting entry is to RE. you’re > thinking of IS adjustments Okay that makes sense. Once the liquidation is complete it would effectively change RE as I was saying above. Of course at that point the LIFO reserve would be gone and the analyst wouldn’t have to make any adjustments to RE. Does that sound right to you slash?
dinesh.sundrani Wrote: ------------------------------------------------------- > A = L + E > > A (inventory) increase by 125,000, so depreciation > increases (i.e Liabilities) and retained earning > from equity increases by LIFOReserve*(1 - TR) = > 125000*(1-0.36) = 80000 > > > = + . > > is this correct??? That doesn’t look right to me dinesh only because assets aren’t actually being written up, so your depreciaton won’t be going up. I think the tax adjustment has to due with the fact that once the lifo liquidation occurs the after tax profits will flow through the income statement and into RE.
mwvt9 Wrote: ------------------------------------------------------- > Slash Wrote: > -------------------------------------------------- > ----- > > the inventory is understated so you have to > adjust > > it up. the offsetting entry is to RE. you’re > > thinking of IS adjustments > > Okay that makes sense. Once the liquidation is > complete it would effectively change RE as I was > saying above. Of course at that point the LIFO > reserve would be gone and the analyst wouldn’t > have to make any adjustments to RE. > > Does that sound right to you slash? when adjusting, i think it’s best to view the financial statements as a snapshot. the BS doesn’t have to correspond with the IS and vise versa also i’m not sure if that’s the correct answer in the first place. is that the complete question? is the company a going concern?
Slash, I guess my question is WHY is the balance sheet adjusted? Is it because inventory levels are actually higher that what book says because of LIFO account OR is it because in the event of a LIFO liquidation (that is listed as likely) the higher profits are going to run through the IS and then to the BS?
“Also, the probability of a LIFO liquidation is high.” my bad. i guess this implies that the company is no longer a going concern. thus, liquidation is imminent. that’s why it’s adjusted on a tax basis. however, i’m not sure where the 45k goes. my guess would be deferred taxes. someone confirm
mwvt9 Wrote: ------------------------------------------------------- > Slash, > > I guess my question is WHY is the balance sheet > adjusted? Is it because inventory levels are > actually higher that what book says because of > LIFO account OR is it because in the event of a > LIFO liquidation (that is listed as likely) the > higher profits are going to run through the IS and > then to the BS? it’s adjusted because the inventory is understated, not because of whatever is going on in the IS and it flowing through to the BS. this is how i interpreted it when i read it
I am not sure you are wrong slash. It is possible to have a LIFO liquidation and still have the company as a going concern. The 45K would go the the government though (at least the way I am thinking about this).
Slash Wrote: ------------------------------------------------------- > mwvt9 Wrote: > -------------------------------------------------- > ----- > > Slash, > > > > I guess my question is WHY is the balance sheet > > adjusted? Is it because inventory levels are > > actually higher that what book says because of > > LIFO account OR is it because in the event of a > > LIFO liquidation (that is listed as likely) the > > higher profits are going to run through the IS > and > > then to the BS? > > it’s adjusted because the inventory is > understated, not because of whatever is going on > in the IS and it flowing through to the BS. this > is how i interpreted it when i read it Ok. Do you know where I can find this in the books or is this something I should know from level I?
mwvt9 Wrote: ------------------------------------------------------- > dinesh.sundrani Wrote: > -------------------------------------------------- > ----- > > A = L + E > > > > A (inventory) increase by 125,000, so > depreciation > > increases (i.e Liabilities) and retained > earning > > from equity increases by LIFOReserve*(1 - TR) = > > 125000*(1-0.36) = 80000 > > > > > > = + . > > > > is this correct??? > > That doesn’t look right to me dinesh only because > assets aren’t actually being written up, so your > depreciaton won’t be going up. > > I think the tax adjustment has to due with the > fact that once the lifo liquidation occurs the > after tax profits will flow through the income > statement and into RE. I think you are correct mwvt9, I have written all crap above and need to redo my FSA readings. Sorry for the mess.
> Ok. Do you know where I can find this in the > books or is this something I should know from > level I? it’s in the CFAI book. my memory is foggy. i’m urging everyone to just read it themselves
I am not sure that I am right. See slash’s comments above. He may be correct in that the RE adjustment has nothing to with the future low cost COGS running through the IS. If that is the case then I don’t know where the 45K would be booked.
Slash Wrote: ------------------------------------------------------- > i’m > urging everyone to just read it themselves Are you implying that I haven’t read all the required reading by the CFAI? HA HA HA HA Live by the schweser, die by the schweser.
> Are you implying that I haven’t read all the > required reading by the CFAI? HA HA HA HA not even close. > Live by the schweser, die by the schweser. yeah schweser is easier but a lot of the material is garbage. just to add a bit of justification for the above topic- in the end we’re doing adjustments to gain a better representation of of a company’s financial state. these aren’t really standardized processes which follow strict accounting rules. so i highly doubt that the retained earnings are from the IS. rather, it’s a standalone adjustment to the BS
I started with the CFAI materials, but unforseen circumstance led me back to Schweser in the interest of time. Your explanation makes more sense than mine. Do you know why you would be using the after tax number of the LIFO reserve then?
From what I know, LIFO liquidation means the COGS will be very low because old inventory will be sold off. So, the Net Income will be abnormally high–> Retained EArnings will be very high too. So, we need to bring it down by 36k*(1-0.36)
You lost me ruhi. Where did you get 36K?