CA 8-6

(a)    Inventory profits occur when the inventory costs matched against sales are less than the replace-ment cost of the inventory. The cost of goods sold therefore is understated and net income is con-sidered overstated. By using LIFO (rather than some method such as FIFO), more recent costs are matched against revenues and inventory profits are thereby reduced.

(b)    As long as the price level increases and inventory quantities do not decrease, a deferral of income taxes occurs under LIFO because the items most recently purchased at the higher price level are matched against revenues. It should be noted that where unit costs tend to decrease as production increases, the tax benefits that LIFO might provide are nullified. Also, where the inventory turnover is high, the difference between inventory methods is negligible.

CA 8-10

(a)    FIFO (Amounts in thousands, except earnings per share)

2014        2015        2016
Sales revenue    $11,000        $12,000        $15,600
Cost of goods sold
Beginning inventory        8,000            7,200            9,000
Purchases        8,000            9,900          12,000
Cost of goods available for sale      16,000          17,100            21,000
1.   Ending inventory*       (7,200)               (9,000)            (9,000)
Cost of goods sold        8,800            8,100          12,000
Gross profit        2,200            3,900            3,600
Operating expense (15% of sales)    1,650          1,800           2,340
Depreciation expense           300           300               300
Income before taxes           250            1,800              960
Income tax expense (40%)           100               720               384
2.   Net income    $     150        $  1,080        $     576

CA 8-10 (Continued)

2014        2015        2016
3.   Earnings per share    $    0.15        $    1.08        $   0.58

4.   Cash balance
Beginning balance    $     400        $  1,150        $      230
Sales proceeds      11,000          12,000          15,600
Purchases      (8,000)         (9,900)        (12,000)
Operating expenses      (1,650)         (1,800)          (2,340)
Property, plant, and equipment         (350)             (350)             (350)
Income taxes          (100)              (720)              (384)
Dividends          (150)              (150)              (150)
Ending balance    $  1,150        $     230        $     606

*2014 = $  8 X (1,000 + 1,000 – 1,100) = $7,200.
2015 = $  9 X (   900 + 1,100 – 1,000) = $9,000.
2016 = $10 X (1,000 + 1,200 – 1,300) = $9,000.

LIFO (Amounts in thousands, except earnings per share)

2014        2015        2016
Sales revenue    $11,000        $12,000        $15,600
Cost of goods sold
Beginning inventory        8,000            7,200            8,100
Purchases        8,000            9,900          12,000
Cost of goods available for sale      16,000          17,100            20,100
1.  Ending inventory**       (7,200)               (8,100)            (7,200)
Cost of goods sold        8,800            9,000          12,900
Gross profit        2,200            3,000            2,700
Operating expense      1,650          1,800         2,340
Depreciation expense           300                300               300
Income before taxes        250               900            60
Income tax expense           100               360                 24

2.  Net income    $     150        $     540        $       36

3.  Earnings per share    $    0.15        $    0.54        $    0.04

CA 8-10 (Continued)

2014        2015        2016
4.  Cash balance
Beginning balance    $     400        $ 1,150        $     590
Sales proceeds      11,000          12,000          15,600
Purchases      (8,000)         (9,900)        (12,000)
Operating expenses      (1,650)          (1,800)          (2,340)
Property, plant, and equipment         (350)              (350)             (350)
Income taxes          (100)             (360)               (24)
Dividends          (150)             (150)            (150)
Ending balance    $  1,150        $    590        $  1,326

**2014 =   $8 X (1,000 + 1,000 – 1,100) = $7,200.
2015 = ($8 X 900) + ($9 X 100) = $8,100.
2014 =   $8 X 900 = $7,200.

(b)    According to the computation in (a), Harrisburg Company can achieve the goal of income tax savings by switching to the LIFO method. As shown in the schedules, under the LIFO method, Harrisburg will have lower net income and thus lower income taxes for 2015 and 2016 (tax savings of $360,000 in each year). As a result, Harrisburg will have a better cash position at the end of 2015 and especially 2016 (year-end cash balance will be higher by $360,000 for 2015 and $720,000 for 2016).

However, since Harrisburg Company is in a period of rising purchase prices, the LIFO method will result in significantly lower net income and earnings per share for 2015 and 2016. The management may need to evaluate the potential impact that lower net income and earnings per share might have on the company before deciding on the change to the LIFO method.

CA 8-6

(a)    Inventory profits occur when the inventory costs matched against sales are less than the replace-ment cost of the inventory. The cost of goods sold therefore is understated and net income is con-sidered overstated. By using LIFO (rather than some method such as FIFO), more recent costs are matched against revenues and inventory profits are thereby reduced.

(b)    As long as the price level increases and inventory quantities do not decrease, a deferral of income taxes occurs under LIFO because the items most recently purchased at the higher price level are matched against revenues. It should be noted that where unit costs tend to decrease as production increases, the tax benefits that LIFO might provide are nullified. Also, where the inventory turnover is high, the difference between inventory methods is negligible.

CA 8-10

(a)    FIFO (Amounts in thousands, except earnings per share)

2014        2015        2016
Sales revenue    $11,000        $12,000        $15,600
Cost of goods sold
Beginning inventory        8,000            7,200            9,000
Purchases        8,000            9,900          12,000
Cost of goods available for sale      16,000          17,100            21,000
1.   Ending inventory*       (7,200)               (9,000)            (9,000)
Cost of goods sold        8,800            8,100          12,000
Gross profit        2,200            3,900            3,600
Operating expense (15% of sales)    1,650          1,800           2,340
Depreciation expense           300           300               300
Income before taxes           250            1,800              960
Income tax expense (40%)           100               720               384
2.   Net income    $     150        $  1,080        $     576

CA 8-10 (Continued)

2014        2015        2016
3.   Earnings per share    $    0.15        $    1.08        $   0.58

4.   Cash balance
Beginning balance    $     400        $  1,150        $      230
Sales proceeds      11,000          12,000          15,600
Purchases      (8,000)         (9,900)        (12,000)
Operating expenses      (1,650)         (1,800)          (2,340)
Property, plant, and equipment         (350)             (350)             (350)
Income taxes          (100)              (720)              (384)
Dividends          (150)              (150)              (150)
Ending balance    $  1,150        $     230        $     606

*2014 = $  8 X (1,000 + 1,000 – 1,100) = $7,200.
2015 = $  9 X (   900 + 1,100 – 1,000) = $9,000.
2016 = $10 X (1,000 + 1,200 – 1,300) = $9,000.

LIFO (Amounts in thousands, except earnings per share)

2014        2015        2016
Sales revenue    $11,000        $12,000        $15,600
Cost of goods sold
Beginning inventory        8,000            7,200            8,100
Purchases        8,000            9,900          12,000
Cost of goods available for sale      16,000          17,100            20,100
1.  Ending inventory**       (7,200)               (8,100)            (7,200)
Cost of goods sold        8,800            9,000          12,900
Gross profit        2,200            3,000            2,700
Operating expense      1,650          1,800         2,340
Depreciation expense           300                300               300
Income before taxes        250               900            60
Income tax expense           100               360                 24

2.  Net income    $     150        $     540        $       36

3.  Earnings per share    $    0.15        $    0.54        $    0.04

CA 8-10 (Continued)

2014        2015        2016
4.  Cash balance
Beginning balance    $     400        $ 1,150        $     590
Sales proceeds      11,000          12,000          15,600
Purchases      (8,000)         (9,900)        (12,000)
Operating expenses      (1,650)          (1,800)          (2,340)
Property, plant, and equipment         (350)              (350)             (350)
Income taxes          (100)             (360)               (24)
Dividends          (150)             (150)            (150)
Ending balance    $  1,150        $    590        $  1,326

**2014 =   $8 X (1,000 + 1,000 – 1,100) = $7,200.
2015 = ($8 X 900) + ($9 X 100) = $8,100.
2014 =   $8 X 900 = $7,200.

(b)    According to the computation in (a), Harrisburg Company can achieve the goal of income tax savings by switching to the LIFO method. As shown in the schedules, under the LIFO method, Harrisburg will have lower net income and thus lower income taxes for 2015 and 2016 (tax savings of $360,000 in each year). As a result, Harrisburg will have a better cash position at the end of 2015 and especially 2016 (year-end cash balance will be higher by $360,000 for 2015 and $720,000 for 2016).

However, since Harrisburg Company is in a period of rising purchase prices, the LIFO method will result in significantly lower net income and earnings per share for 2015 and 2016. The management may need to evaluate the potential impact that lower net income and earnings per share might have on the company before deciding on the change to the LIFO method.

CA 8-6

(a)    Inventory profits occur when the inventory costs matched against sales are less than the replace-ment cost of the inventory. The cost of goods sold therefore is understated and net income is con-sidered overstated. By using LIFO (rather than some method such as FIFO), more recent costs are matched against revenues and inventory profits are thereby reduced.

(b)    As long as the price level increases and inventory quantities do not decrease, a deferral of income taxes occurs under LIFO because the items most recently purchased at the higher price level are matched against revenues. It should be noted that where unit costs tend to decrease as production increases, the tax benefits that LIFO might provide are nullified. Also, where the inventory turnover is high, the difference between inventory methods is negligible.

CA 8-10

(a)    FIFO (Amounts in thousands, except earnings per share)

2014        2015        2016
Sales revenue    $11,000        $12,000        $15,600
Cost of goods sold
Beginning inventory        8,000            7,200            9,000
Purchases        8,000            9,900          12,000
Cost of goods available for sale      16,000          17,100            21,000
1.   Ending inventory*       (7,200)               (9,000)            (9,000)
Cost of goods sold        8,800            8,100          12,000
Gross profit        2,200            3,900            3,600
Operating expense (15% of sales)    1,650          1,800           2,340
Depreciation expense           300           300               300
Income before taxes           250            1,800              960
Income tax expense (40%)           100               720               384
2.   Net income    $     150        $  1,080        $     576

CA 8-10 (Continued)

2014        2015        2016
3.   Earnings per share    $    0.15        $    1.08        $   0.58

4.   Cash balance
Beginning balance    $     400        $  1,150        $      230
Sales proceeds      11,000          12,000          15,600
Purchases      (8,000)         (9,900)        (12,000)
Operating expenses      (1,650)         (1,800)          (2,340)
Property, plant, and equipment         (350)             (350)             (350)
Income taxes          (100)              (720)              (384)
Dividends          (150)              (150)              (150)
Ending balance    $  1,150        $     230        $     606

*2014 = $  8 X (1,000 + 1,000 – 1,100) = $7,200.
2015 = $  9 X (   900 + 1,100 – 1,000) = $9,000.
2016 = $10 X (1,000 + 1,200 – 1,300) = $9,000.

LIFO (Amounts in thousands, except earnings per share)

2014        2015        2016
Sales revenue    $11,000        $12,000        $15,600
Cost of goods sold
Beginning inventory        8,000            7,200            8,100
Purchases        8,000            9,900          12,000
Cost of goods available for sale      16,000          17,100            20,100
1.  Ending inventory**       (7,200)               (8,100)            (7,200)
Cost of goods sold        8,800            9,000          12,900
Gross profit        2,200            3,000            2,700
Operating expense      1,650          1,800         2,340
Depreciation expense           300                300               300
Income before taxes        250               900            60
Income tax expense           100               360                 24

2.  Net income    $     150        $     540        $       36

3.  Earnings per share    $    0.15        $    0.54        $    0.04

CA 8-10 (Continued)

2014        2015        2016
4.  Cash balance
Beginning balance    $     400        $ 1,150        $     590
Sales proceeds      11,000          12,000          15,600
Purchases      (8,000)         (9,900)        (12,000)
Operating expenses      (1,650)          (1,800)          (2,340)
Property, plant, and equipment         (350)              (350)             (350)
Income taxes          (100)             (360)               (24)
Dividends          (150)             (150)            (150)
Ending balance    $  1,150        $    590        $  1,326

**2014 =   $8 X (1,000 + 1,000 – 1,100) = $7,200.
2015 = ($8 X 900) + ($9 X 100) = $8,100.
2014 =   $8 X 900 = $7,200.

(b)    According to the computation in (a), Harrisburg Company can achieve the goal of income tax savings by switching to the LIFO method. As shown in the schedules, under the LIFO method, Harrisburg will have lower net income and thus lower income taxes for 2015 and 2016 (tax savings of $360,000 in each year). As a result, Harrisburg will have a better cash position at the end of 2015 and especially 2016 (year-end cash balance will be higher by $360,000 for 2015 and $720,000 for 2016).

However, since Harrisburg Company is in a period of rising purchase prices, the LIFO method will result in significantly lower net income and earnings per share for 2015 and 2016. The management may need to evaluate the potential impact that lower net income and earnings per share might have on the company before deciding on the change to the LIFO method.