Home Forums CFA CFA Level 1 Financial Accounting (LIFO) question

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  • #2125

    cool_dude117
    Participant

    Here are the data.
    Years 2002 2001 2000
    Net Income (LIFO) 3557 3541 3537
    Inventory 8781 7204 6351
    LIFO Reserve 3183 2617 2403
    Tax rate 20% 30% 30%

    What is the total tax savings that above company has generated through 2002 by using LIFO instead of FIFO Method?

    I understand that, between FIFO and LIFO, the net income for FIFO is higher than LIFO, therefore more tax is paid under FIFO compared to LIFO. I understand that the difference between both net incomes is the LIFO reserve.

    I calculated the tax saving for the following years using change in LIFO reserve * tax rate:
    2002 0.2 * (3183 – 2617) = 0.2 * 566 = 113.2
    2001 0.3 * (2617 – 2403) = 0.3 * 214 = 64.2

    While according to the answer, the whole LIFO reserve for 2001 should be used to compute the tax saving. I was wondering why.

    • This topic was modified 1 year, 6 months ago by  admin.
    • This topic was modified 1 year, 6 months ago by  admin.
    #2140

    admin
    Keymaster

    LIFO reserve represents the cumulative amount of income understatement over the years. If you want to find out how much taxes you would have paid had you not understated your income.

    For example, if the company decided to change from LIFO to FIFO at the year of 2001. It should recognize the whole LIFO reserve when computing its net income. Therefore, it is logical to take the whole LIFO reserve to compute the tax saving.
    LIFO reserve represents the cumulative amount of income understatement over the years. If you want to find out how much taxes you would have paid had you not understated your income.

    For example, if the company decided to change from LIFO to FIFO at the year of 2001. It should recognize the whole LIFO reserve when computing its net income. Therefore, it is logical to take the whole LIFO reserve to compute the tax saving.

    #2141

    admin
    Keymaster

    LIFO reserve represents the cumulative amount of income understatement over the years. If you want to find out how much taxes you would have paid had you not understated your income.

    For example, if the company decided to change from LIFO to FIFO at the year of 2001. It should recognize the whole LIFO reserve when computing its net income. Therefore, it is logical to take the whole LIFO reserve to compute the tax saving.
    LIFO reserve represents the cumulative amount of income understatement over the years. If you want to find out how much taxes you would have paid had you not understated your income.

    For example, if the company decided to change from LIFO to FIFO at the year of 2001. It should recognize the whole LIFO reserve when computing its net income. Therefore, it is logical to take the whole LIFO reserve to compute the tax saving.

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