Chapter 7, Problem 10P

1.

To determine

Ascertain the LIFO liquidation profit to be reported by Company H if no further purchases are made.

Explanation of Solution

Last-in-First-Out (LIFO): In this method, items purchased recently are sold first. So, the value of the ending inventory consist the initial cost for the remaining unsold items.

Cost of goods sold: Cost of goods sold is the total of all the expenses incurred by a company to sell the goods during the given period.

Calculate the ending inventory as per FIFO:

The ending inventory as per FIFO is $48,000$\left(6,000\text{ units }\times \$8\right)$.

Calculate the ending inventory as per LIFO:

Particulars	Amount ($)
2,000 units at $5 per unit $\left(2,000\times \$5\right)$	$ 10,000
3,000 units at $6 per unit $\left(3,000\times \$6\right)$	$ 18,000
1,000 units at $8 per unit $\left(1,000\times \$8\right)$	$ 8,000
Ending inventory	$ 36,000

Table (1)

Compute the LIFO Liquidation units:

$\begin{array}{c}\text{LIFO Liquidation units = Units Sold }-\text{ Units purchased}\\ \text{=}22,000-19,000\\ =3,000\text{ units}\end{array}$

Compute the LIFO Liquidation Profit:

$\begin{array}{c}\text{LIFO Liquidation Profit = }\left[\text{1},000\times \left(\$10-\$8\right)\right]+\left[2,000\times \left(\$10-\$6\right)\right]\\ =\left(1,000\times \$2\right)+\left(2,000\times \$4\right)\\ =\$2,000\text{ +\$8,000}\\ \text{=\$10,000}\end{array}$

Compute the LIFO Liquidation Profit after tax:

$\begin{array}{c}\begin{array}{l}\text{LIFO Liquidation }\\ \text{Profit after tax }\end{array}\}\text{= }\left(\begin{array}{l}\text{LIFO Liquidation}\\ \text{ Profit}\end{array}\right)\times \text{Tax Rate}\\ =\text{\$10,000}\times \text{0}\text{.70}\\ \text{=\$7,000}\end{array}$

2.

To determine

Prepare the disclosure annual report for 2017.

Explanation of Solution

The following disclosure is made that the increase in the demand of the products has resulted in the fall of the physical quantity of the inventory. The liquidation of LIFO results in a profit of $7,000. The following inventory information is as well disclosed.

Particulars	2017	2016
Inventory at FIFO	$ 30,000	$ 48,000
Less: Inventory at LIFO	$ 16,000	$ 36,000
LIFO valuation allowance	$ 14,000	$ 12,000

Table (2)

3.

To determine

Ascertain the tax savings which can be made by an additional purchase for $7,000.

Explanation of Solution

The purchase worth of $7,000 results in no liquidation profit, thus the income taxes on that amount is saved.

Compute the LIFO Liquidation Profit after tax:

$\begin{array}{c}\begin{array}{l}\text{Income taxes}\\ \text{saved}\end{array}\}\text{= }\left(\begin{array}{l}\text{LIFO Liquidation}\\ \text{ Profit}\end{array}\right)\times \text{Tax Rate}\\ =\text{\$10,000}\times \text{0}\text{.30}\\ \text{=\$3,000}\end{array}$

The tax savings which can be made by an additional purchase for $7,000 is $2,100.

4.

To determine

Ascertain the tax savings which can be made by an additional purchase for $7,000, over a period of 4 years.

Explanation of Solution

The purchase worth of $7,000 results in no liquidation profit, thus the profit on that amount is saved.

The final inventory as on December 31 is 10,000 units $6,000+\left(19,000+7,000\right)-22,000$.

Calculate the ending inventory as per FIFO:

The ending inventory as per FIFO is $100,000$\left(10,000\text{ units }\times \$10\right)$.

Calculate the ending inventory as per LIFO:

Particulars	Amount ($)
6,000 units at $6 per unit $\left(6,000\times \$6\right)$	$ 36,000
4,000 units at $10 per unit $\left(4,000\times \$10\right)$	$ 40,000
Ending inventory	$ 76,000

Table (3)

Compute the LIFO Liquidation Profit after tax:

$\begin{array}{c}\begin{array}{l}\text{Income taxes}\\ \text{saved}\end{array}\}\text{= }\left(\begin{array}{l}\text{LIFO Liquidation}\\ \text{ Profit}\end{array}\right)\times \text{Tax Rate}\\ =\left(\text{\$100,000}-\$76,000\right)\times \text{30\%}\\ \text{=\$24,000}\times \text{30\%}\\ \text{=\$7,200}\end{array}$

The tax savings which can be made by an additional purchase for $7,000 is $7,200.