Hi everyone,
Stumped on this example in Schweser Book 2 Reading #17 Example : Converting from LIFO to FIFO:
” Current Assets (20X6) = $630. Current Liabilities = $325
Inventory Info: The company uses LIFO inventory cost flow method. Had FIFO been used, inventories would have been $100 higher in 20X6 and $90 higher in 20X5.
Income Tax Info : effective tax rate for 20X6 was 30%. For all other years, the effective tax rate was 20%
Answer to find Current Ratio for LIFO & FIFO:
THe current ratio (current assets/current liabilities) under LIFO is $630 / $325 = 1.9
To convert to FIFO, the 20X6 LIFO reserve of $100 is added to current assests (inventory) and income taxes on the 20X6 LIFO reserve are calculated at a blended rate as follows:
20% rate $18 ($90 20X5 reserve x 20%)
30% rate $ 3 ($100 20X6 reserve - $90 20X5 reserve) x 30%
Taxes on 20X6 Reserve = $18+$3 = $21
Thus under FIFO, the current ratio is ($630 + $100 LIFO reserve - $21 taxes) / $325 = 2.2”
I don’t understand why the income taxes are calculated using the blended rate when the ratio is for 20X6 Current Ratio, shouldnt the income tax be simply based on 30% rate : ($100 x 30%) = $30 ?
I must be missing something here.
Does anyone know?
Appreciate any help.
Thanks everyone.
Stumped on this example in Schweser Book 2 Reading #17 Example : Converting from LIFO to FIFO:
” Current Assets (20X6) = $630. Current Liabilities = $325
Inventory Info: The company uses LIFO inventory cost flow method. Had FIFO been used, inventories would have been $100 higher in 20X6 and $90 higher in 20X5.
Income Tax Info : effective tax rate for 20X6 was 30%. For all other years, the effective tax rate was 20%
Answer to find Current Ratio for LIFO & FIFO:
THe current ratio (current assets/current liabilities) under LIFO is $630 / $325 = 1.9
To convert to FIFO, the 20X6 LIFO reserve of $100 is added to current assests (inventory) and income taxes on the 20X6 LIFO reserve are calculated at a blended rate as follows:
20% rate $18 ($90 20X5 reserve x 20%)
30% rate $ 3 ($100 20X6 reserve - $90 20X5 reserve) x 30%
Taxes on 20X6 Reserve = $18+$3 = $21
Thus under FIFO, the current ratio is ($630 + $100 LIFO reserve - $21 taxes) / $325 = 2.2”
I don’t understand why the income taxes are calculated using the blended rate when the ratio is for 20X6 Current Ratio, shouldnt the income tax be simply based on 30% rate : ($100 x 30%) = $30 ?
I must be missing something here.
Does anyone know?
Appreciate any help.
Thanks everyone.