# LIFO/FIFO

Selected financial data from Krandall, Inc.’s balance sheet for the year ended December 31 was as follows (in \$): Cash \$1,100,000 Accounts Receivable 300,000 Inventory 2,400,000 Property, Plant & Eq. 8,000,000 Total Assets 11,800,000 Accounts Payable \$400,000 Deferred Tax Liability 700,000 Long-term Debt 8,200,000 Common Stock 1,000,000 Retained Earnings 1,500,000 Total Liabilities & Equity 11,800,000 LIFO Reserve at Jan. 1 600,000 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) 4.06 B) 3.63 C) 3.73 D) 4.18 Help guys…

FIFO Inventory would be 900.000 higher therefore total assets @ FIFO would be 12.700.000 Change in LIFO reserve = +300.000 COGS @ FIFO would be 300.000 less so profit before tax would be 300.000. Tax = 40%*300.000=120.000, therefore net income and retained earnings would be 180.000 higher Equity = 1.000.000 + 1.500.000 + 180.000 = 2.680.000 I understand that the company pays any additional tax which means DR Tax payable 120.000 and CR Cash 120.000, i.e. total assets will lower by 120.000 and the final assets would be 12.700.000 - 120.000 = 12.580.000 Assets/ Equity = 12.580.000/ 2.680.000 = 4.69 (the nearest is D by isn’t the difference too much??) I am not sure!!!

initial asset to equity: 11,800,000/2,500,000=4.72 adjustment for inventory method: assets: inventory increase by 300,000 -> asset increase by 300,000 -> 12,100,000 income = 300,000*(1-.4)=180,000 -> retained earnings increase by 180,000 -> equity increase to 2,680,000 DTL is increased by 120,000 assets/equity = 12,100,000/2,680,000=4.51 -> closest to D.

Answer is A. 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. why do they say that pretax income will be higher by 900,000? COGS should change by 300,000 only. right?

Auch, I totally messed up with adjustments … inventory should be adjusted by 900,000. If we assume taxes are paid, then there is no adjustment to DTL. Time to review adjustments …

It is Cumulative Pre tax income, not just this year’s income. In the current year the COGs would reduce by 300,000, but in the previous years it should have reduced by a total of 600,00, equal to the beginning of the LIFO reserve. Since this is an accounting method change, they are retrospective and hence the tax has to be paid on the cumulative increase in the pre tax income.