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%, what will be the adjusted value of retained earnings? A) $1,820,000. B) $1,855,000. C) $1,980,000. Analysts must also check the footnotes to determine if the firm has engaged in a LIFO liquidation. A LIFO liquidation involves selling more goods than a:e replaced; thus, the firm penetrates the older, lower cost layers of inventory thereby increasing profit. The profitability is not sustainable; however, because the firm will eventually run out of older, cheaper invenrory. For analytical purposes, the profit from the liquidation should be remoi~ed from the income statement. Correct Answer is C I put A because I removed the possible profit from the Lifo liquidation… Also the adjustment to the balance sheet doesnt takes into account the tax, unless it is for removing the LIFO liquidation right?
The way I think about it is that, since the lower cheaper invesntory levels were reached due to LIFO Liquidation, the COGS would be lower and hence the RE would be higher. So the only number greater that 1.9m is C. 1.9 + 125*0.64 = 19.8
C. Its the only number higher, noticing that saves time.
Don’t we want to reverse the effect of LIFO liquidation?
LIFO Liquidation would cause the higher earnings… and that is precisely what is being reflected here.
I’m sorry that I’m so confused by this right now. I’m ready to move on but first hear me out: If LIFO liquidation causes higher earnings, Schweser and CFAI says to undo the lower COGS. I guess this question states what earnings would likely bel be rather than what adjustments should be made for analytical purposes as per reading 27
I think this is because the question states - Probability of LIFO liquidation is high. But LIFO Liquidation itself has not occurred…
i think that’s what they’re asking. they say the RE is 1.9, you want to back out the shadyness of the LIFO liquidation from it. and that part would’ve been the 125k x .64 profit to the bottom line. i can’t say this question was worded beautifully, but yeah, like what ali said… i think they wanted you to see the 80k and then back it out since it was due to a LIFO liquidation?
whoops i read the q wrong. if they are asking the RE b/c of the lifo liq, then yeah- add that 125 x .64 to get the bigger #. i’m losing my mind.