FSA Question

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: Answer is: 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. What I don’t understand is why ending lifo reserve was used instead of change in lifo reserve to calculate income effect. any help would be appreciated! thanks!

Try looking up the formula for converting LIFO inventory to FIFO inventory. Just remember that during the time of stable/rising prices, Inventory is always higher under FIFO by the amount of the LIFO reserve (not the change in LIFO reserve).

but shouldn’t we consider FIFOcogs as well for the effect on equity (tru net income >retained earning) ?