LIFO => FIFO Bal Sheet Conversion

[dea_cfa]

Selected financial data from Krandall, Inc.�s financial statements for the year ended December 31 was as follows (in $):

Cash
$100,000
Accounts Payable
$400,000

Accounts Receivable
300,000
Deferred Tax Liability
700,000

Inventory
2,400,000
Long-term Debt
8,200,000

Property, Plant & Eq.
9,000,000
Common Stock
1,000,000

Total Assets
11,800,000
Retained Earnings
1,500,000

LIFO Reserve at Jan. 1
600,000
Total Liabilities & Equity
11,800,000

LIFO Reserve at Dec. 31
900,000




Krandall uses the last in, first out (LIFO) inventory cost flow assumption. The tax rate is 40 percent. If Krandall changed from LIFO to first in, first out (FIFO), the assets-to-equity ratio would:

A) increase from 4.72 to 5.08.

B) decrease from 4.72 to 4.18.

C) decrease from 4.72 to 3.74.

D) decrease from 4.72 to 4.54.


Your answer: C was incorrect. The correct answer was B) decrease from 4.72 to 4.18.

Assets-to-equity under LIFO is ($11,800,000 / $2,500,000 =) 4.72. With a change from LIFO to FIFO inventory would increase by the amount of the ending LIFO reserve, so total assets under FIFO would be ($11,800,000 + $900,000 =) $12,700,000. Retained earnings would increase by (ending LIFO reserve * (1 � tax rate)) = ($900,000 (1 � 0.40) =) $540,000. The assets-to-equity ratio under FIFO is ($12,700,000 / ($1,000,000 + $1,500,000 + $540,000) =) 4.18.

*****I understand everything except how the intergrity of A=L+E is maintained. If Assets increase 900k and R/E increases 450k, which liability account increases 450k?****

Thanks,
dea

 

[ymc]

Long Term Deferred Tax Liability

 

[dea_cfa]

Thanks ymc!

 

[disptra]

Are you sure retained earning calcuation is correct. It should use COGS difference which is 300,000 instead of 900,000.

 

[cfafsa]

I tend to agree with disptra too. the denominator - equity calc. does not take the delta of COGS.

Since,
COGS_fifo = COGS_lifo - (LIFO Reserve_ending - LIFO Reserve_begin)
Hence COGS_fifo has a net less cost of = 900,000 - 600,000 = 300,000.
Due to this tax saving is : 300,000 * (1 - 0.4) = 180,000. This gets added to equity.

Thus equity is: 2,500,000 + 180,000 = 2,680,000

and Assets/Equity = (11,800,000 + 900,000) / ( 2,500,000 + 180,000) = 4.73

Can anyone clarify this?

 

[EngAudListCo_Director]

Hi

Just to add to on. For dea, the liability account should not be 450K but 360K. I.e Dr Tax Expense 360K, Cr Deferred Tax Liability 360K. Think you mistakenly typed 540K as 450K and as such thought the tax expense is 900K-450K.

As for cfafsa, you are not totally wrong in your last thread but you have to note that the beginning LIFO reserve has to tie to the liabilities and equities side and this 600K is Cr into retained earnings and DTL accordingly based on 40% tax rate.

As such the adjusted FIFO accounts should look like below


Current Assets
Cash 100K
AR 300K
Inv(FIFO adj) 3,300K

Non Current Assets
PPE 9,000K

Total 12,700K

Liability
Accounts Payable 400K
DTL 1,060K
LTD 8,200K

Equity
Common Stock 1,000K
Retained Earn 2,040K

Total 12,700K

 

[cfafsa]

Thanks EngAudListCo_Director. Your explaination is very lucid. I simply added the increase to the Equity and not the begining balance to adjust the R/E then. I further have a question for clarification.

If a company goes from a LIFO to FIFO in accounting statements, the DTL balance increases assuming all other things are equal. It seems logical this happens as FIFO tax expense increases and hence this has to be compensated by a increase in deferred expense (in case a liability) since tax payable is the same.