Why is that?

[pierovic18]

23) Which of the following methods of accounting for inventory will result in the highest after-tax cash flow during a deflationary period?


(a) Specific identification method
(b) Average cost method
(c) LIFO
(d) FIFO


Fifo is the answer...what is after tax cash flow? "After-tax cash flows will be highest when taxes are at their lowest"

 

[Rydex]

Fifo would create the greater after tax cash flow because cost of goods sold will be higher due to the "deflationary period", cogs under lifo will be less than cogs under fifo. Hgher fifo cogs leads to less pretax income, and lower taxes in a deflationary period. The opposite is true for an inflationary period.

 

[jamespucyk]

Accounting for Last in First out (LIFO) creates a higher cost base or COGS in general. This, all other things constant and assuming a general inflationary environment would create lower taxable income and lower taxes as such and therefore lower Net Income. CFO is not effected by accounting methods for depreciation (aside from it's impact on taxable income) so the only tangible effect of LIFO assuming a general inflationary environment is higher CFO (lower taxes). This is the only real effect.

Deflation corresponds to a general decrease in price level, usually for the main asset used in production or COGS. This would mean that as you are accounting using the LIFO method you would actually have higher Net Income, CFO will be lower in a deflationary environment. FIFO on the other hand will result in a higher COGS and lower taxes paid; higher CFO because as price levels drop the initial inventory is accounted for first in COGs and thus higher COGS.

The key here is to recognize that CFO is not effected by accounting methods for depreciation, aside from the effect on taxable income, therefore after tax cash flows are lower under the FIFO method assuming deflation.



Edited 1 time(s). Last edit at Monday, April 10, 2006 at 11:55PM by jamespucyk.