LIFO reserves

CFA Level II
#1

Dear:

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)].

#2

I think it’s deferred tax liabilities.

#3

I think I agree with Tulips. Once the statements are converted to FIFO basis an imbalance occurs in the accounting equation as firm reporting LIFO ends up paying less taxes. If taxes are not deferred and paid in cash so the cash decreases by LIFO Reserves x Tax rate, Inventory increases by LIFO Reserves and Equity also increases by LIFO Reserves x (1-Tax Rate). Deferred tax liability on the other hand record that the company will pay more tax in the future which it hasn’t paid under the transaction done today. Considering this and converting to FIFO presentation basis Company should pay more tax but in this case the reserve has become negative so I think the decrease is recorded in the deferred tax liability stating that the company is liable to pay less taxes.