# LIFO liquidation

I thought LIFO liquidation UNDERSTATED cogs, so we should adjust the RE LOWER?? Question 20 - #9081 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) \$1,820,000. B) \$1,855,000. C) \$1,980,000. D) \$1,945,000. Your answer: A was incorrect. The correct answer was C) \$1,980,000. The adjustment to retained earnings will be: \$125,000*(1-.36). This question tested from Session 7, Reading 30, LOS b.

Crap. What I typed was wrong, somehow my odd logic netted the right answer. Bank shot. I need those on June 7th.

COGS OVERSTATED, NI UNDERSTANED, RI UNDERSTATED … so adjustment added! RE = RE + LIFOReserve*(1 - TR) 1900K + 125,000*(1 - 0.36) 1900K + 80000 1,980,000 = C

why is COGS OVERSTATED? Isn’t the concept of liquidation dipping into the old inventory which has a lower cost?

Since Co. dipped into older inventory, which would not have happened, if LIFO liquidation had not happened, COGS is overstated. and hence NI and RE are understated. CP

avnx Wrote: ------------------------------------------------------- > I thought LIFO liquidation UNDERSTATED cogs, so we > should adjust the RE LOWER?? > > > Question 20 - #9081 > 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) \$1,820,000. > B) \$1,855,000. > C) \$1,980,000. > D) \$1,945,000. > Your answer: A was incorrect. The correct answer > was C) > \$1,980,000. > The adjustment to retained earnings will be: > \$125,000*(1-.36). > This question tested from Session 7, Reading 30, > LOS b. LIFO liquidation has not happened YET. It may happen and you, as an analyst, want to see what the company looks like if it does. See cpk’s comments above.

crap i am really struggling here. 1)Liquidation -> COGS understate -> NI overstate 2) the goal right now is to negate the effect of liquidation. 3) so we lower the NI guys, what am i missing!!?

anyone? :’(

I can’t make sense out of Dinesh’s adjustment too. I have never seen any place that tells me that I need to adjust the COGS in such a way that to add the LIFO_reserve * (1 - tax). AMOF, COGS_F = COGS_L - Change in LIFO reserve. So if we are adjusting the income statement from LIFO to FIFO, we should change COGS, but using the LIFO is preferred for the income statement analysis. The possible way I can see this answer is correct is by adjusting the balance sheet since it’s better to use FIFO there. Hence Inventory_F = Inventory_L + LIFO_reserve. If inventory goes up; then the A goes up, which will force the RE go up on the right hand side of balance sheet. Any help?

dinesh.sundrani Wrote: ------------------------------------------------------- > COGS OVERSTATED, NI UNDERSTANED, RI UNDERSTATED > … so adjustment added! > > RE = RE + LIFOReserve*(1 - TR) > 1900K + 125,000*(1 - 0.36) > 1900K + 80000 > 1,980,000 = C Hi avnx, sorry to leave it this way. I had called it a night yest and dozed of. But a good sound sleep is not making any difference for this question. I think we need experts here.

This would be used when you are comparing the firm in this question to a FIFO firm. You want to compare apples to apples. If the LIFO liquidation happens then low value COGS will run through the income statement which will increase profits, which will then fall to RE (only the after-tax amount). There are really two ways to look at it. Either you inventor is understated because of LIFO accouting or your the method I used above. That is my take. Either way, when the LIFO liquidation happens profits will be up and RE will be up by the LIFO reserve * (1-TR) EDIT: Not an expert.

Note: the correct way for the adjustment is not directly subtracting the LIFO_reserve, but the Delta_LIFO_reserve. COGS_F = COGS_L - Changes in LIFO reserve

If you use FIFO, the assets go up by the LIFO reserve amount. Now the equation for the B/S is A = L + E Key note here is that the balance sheet has to balance, so the Lefts side has to equal the right side. In this example, assume LIFO reserve is 125,000 and Equity is 1,900,000 and tax rate is 36% Under the FIFO accounting A = L + E A = DTL + E 125,000 = (125,000*0.36) + (125,000*(1-0.36)) 125,000 = 45,000 + 80,000 Therefore, with the LIFO reserve, your RE goes up by 80,000 -----> 1,900,000 + 80,000 = 1,980,000 So the answer would be C

avnx Wrote: ------------------------------------------------------- > crap i am really struggling here. > > 1)Liquidation -> COGS understate -> NI overstate > 2) the goal right now is to negate the effect of > liquidation. > 3) so we lower the NI > > guys, what am i missing!!? Rule number 1: Read the question. It doesn’t say that a LIFO liquidation has already occured and you are to negate it, it says that one will likely occur inn the future, so you are to give it effect now (as if you want to to compare to another company that is currently using FIFO)

What Super said seems to make sense.