As for the problem, is it liability decreased here referred to inventory payable?
Due to declining prices, Steffen Inc. has a LIFO reserve of –$20. Its income tax rate is 35%. If an analyst is converting Steffen’s financial statements to a FIFO basis, which of the following adjustments is most likely required?
A) Increase assets by $20. B) Increase shareholders’ equity by $13. C) Decrease liabilities by $7.
Your answer: C was correct!
Declining prices (negative LIFO reserve) would result in FIFO inventory being less than LIFO inventory based on the following equation:
FIFO inventory = LIFO inventory + LIFO reserve
The balance sheet adjustment would decrease assets (inventory) by the $20 LIFO reserve. In addition, the analyst would decrease liabilities by $7 ($20 LIFO reserve × 35% tax rate). To bring the accounting equation into balance, the analyst would decrease shareholders’ equity by $13 [$20 LIFO reserve × (1 − 35% tax rate)].