FSA adjustment question

sorry, I meant 125k*(1-0.36). Clear sign that I need to sleep. But my reasoning still stands.

> Do you know why you would be using the after tax > number of the LIFO reserve then? it has to do with the company being a going concern. the inventory is being liquidated so they have to pay income taxes. i’m just not sure where it goes (IS or deferred taxes).

ruhi22 Wrote: ------------------------------------------------------- > sorry, I meant 125k*(1-0.36). Clear sign that I > need to sleep. But my reasoning still stands. That is the same reasoning I was using, but slash makes some good points above. I think he may be right. He is saying that this is a balance sheet adjustment that is really just recognizing the fact that the inventory on the books is too low due to LIFO accounting (if and inflationary environ). The only thing that bugs me is that the question states that the LIFO liquidation is likely, which makes me go back to our reasoning of higher profits running through IS due to low COGS. I don’t know. It is almost 1 am. I need to get to bed.

You will definitely have to make an adjustment to your Net Income–>Retained Earnings. I remember this part very clearly from L-I.

Slash Wrote: ------------------------------------------------------- > > Do you know why you would be using the after > tax > > number of the LIFO reserve then? > > it has to do with the company being a going > concern. the inventory is being liquidated so they > have to pay income taxes. i’m just not sure where > it goes (IS or deferred taxes). Maybe we really don’t have a difference of opinion then. It could be looked at from two different angles. One: Adjust the balance sheet to acknowlege the fact than inventory levels are really higher than what the BS says. or Two: Recognize the fact that COGS are low in the LIFO liquidation, therefore your inventory write-up is actually buried in higher net income. Same overall concept. I am not trying to be a pain in the butt here, I am really interested in learning this…

^^ Agree. Both the adjustments are required. You can refer to the White, Sondhi Fried textbook. I have it somewhere; will take a look tomorrow and let you know.

> The only thing that bugs me is that the question > states that the LIFO liquidation is likely, which > makes me go back to our reasoning of higher > profits running through IS due to low COGS. the low COGS has to do with FIFO accounting in an inflationary environment. the liquidation is something else. > I don’t know. It is almost 1 am. I need to get > to bed. word… time to catch some Z-spreads soon

Slash Wrote: ------------------------------------------------------- > > The only thing that bugs me is that the > question > > states that the LIFO liquidation is likely, > which > > makes me go back to our reasoning of higher > > profits running through IS due to low COGS. > > the low COGS has to do with FIFO accounting in an > inflationary environment. the liquidation is > something else. > What? Last in First out would mean that your most expensive inventory is being sold each period. Consequently your cheaper inventory is being left on the books. When you have a LIFO liquidation you are dipping into cheaper inventory, dropping your COGS and showing higher net income.

ok for the purpose of adjustments i categorized the 2 separately due to the taxes. first, ANY company who uses FIFO accounting will adjust their inventory up. second, if there is LIFO liquidation the adjustment will be done on a post-tax basis. this is not for every company that just about sums it up

Maybe its because is so late (why am I up and wasting my time on this instead of surfing for porn or doing something else useful?) but you guys are going nuts on overcomplicating this. It doesn’t have to be about going concern, Just answer the question they asked. Maybe its just because the company across the street from them uses FIFO and when you compare their financials to each other you don’t want to look at apples and oranges. If they’d used FIFO all along they would have had lower CGS, as some have noted, leading to higher taxable income, higher taxes, and higher net income (RE). Assets (inventory) up by 125K, Taxes payable (that you would have had to pay) up by 45K and RE up by the balance, 80K. It’s a proforma adjustment, for what ever reason. It’s not a GAAP adjustment.

^^ I agree with Super I above…(it’s always so easy to say that isn’t it!!) but seriously though…sorry for jumping in this late, but you all are over analysing this. When i read the question i wasn’t thinking of going concern blah blah…I was just looking at the affect on the IS and BS separately. As super said, your total adjustements are Inventory - Up by 125 K your balancing entries (corresponding) should thus be Deferred Tax Liabilities : 125 *(.36) = 45k {This is the amount by which your NI has been higher since LIFO has been used, hence COGS has been higher, NI lower hence taxes paid lower} Equity : 125*(1-.36) = 80k {This could just as well be the plug figure}

Super I Wrote: ------------------------------------------------------- > Maybe its because is so late (why am I up and > wasting my time on this instead of surfing for > porn or doing something else useful?) but you guys > are going nuts on overcomplicating this. > > It doesn’t have to be about going concern, Just > answer the question they asked. > > Maybe its just because the company across the > street from them uses FIFO and when you compare > their financials to each other you don’t want to > look at apples and oranges. > > If they’d used FIFO all along they would have had > lower CGS, as some have noted, leading to higher > taxable income, higher taxes, and higher net > income (RE). > > Assets (inventory) up by 125K, Taxes payable (that > you would have had to pay) up by 45K and RE up by > the balance, 80K. > > It’s a proforma adjustment, for what ever reason. > It’s not a GAAP adjustment. Great. Thanks Super. Makes sense.

Suppose: begining inventory is 1 unit=$2 new purchase is 1 unit=$10 1 unit was sold during the year so the end inventory under LIFO is $2 and under FIFO is $10 and the COGS under LIFO is $10 and under FIFO is $2 then we have LIFO reserve= 10-2=$8 if LIFO liquidation is going on the begining inventory is used as COGS and the COGS decreases by 10-2=$8, which is the LIFO reserve. if COGS decreases by $8, net income increases by 8*(1-tax) and thus the retained earning increases by the same amount. If we replace $8 with $125000, we can get the answer. disclosure: the explanation is based on the correct answer given.