Lewis Corp 6-2

6-2

Lewis Corporation*

Lewis Corporation had traditionally used the FIFO method of inventory valuation. You are given the information shown in exhibit 1 on transactions during the year affecting Lewis’s inventory account. (The purchases are in sequence during the year. The company uses a periodic inventory method).

Exhibit 1 Inventory Transactions 2000-2002--------------------------------------------------- 2000
Beginning Balance 1,840 Cartons @ $20.00
Purchases 600 cartons @ 20.25 800 cartons @ 21.00 &nbs p; 400 cartons @ 21.25 &nbs p; 200 cartons @ 21.50 &nbs p;
Sales &nbs p; 2,820 cartons @ 34.00

2001
Beginning Balance &nbs p; 1,020 cartons
Purchases &nbs p; 700 cartons @ 21.50 &nbs p; 700 cartons @ 21.50 &nbs p; 700 cartons @ 22.00 &nbs p; 1,000 cartons @ 22.25

Sales &nbs p; 3,080 cartons @ 35.75

2002
Beginning Balance &nb sp; 1,040 cartons
Purchases &nbs p; 1,000 cartons @ 22.50 &nbs p; 700 cartons @ 22.75 &nbs p; 700 cartons @ 23.00 &nbs p; 700 cartons @ 23.50

Sales &nbs p; 2,950 cartons @ 35.75

Questions

1). Calculate the cost of goods sold and year-end inventory amounts for 2000, 2001, and 2002 using the (a) FIFO, (b) LIFO, and (c) average cost methods.

2). Lewis Corporation is considering switching from FIFO to LIFO to reduce its income tax expense. Assuming a corporate income tax rate of 40 percent, calculate the tax savings this would have made for 2000 to 2002. Would you recommend that Lewis make the change?

3). Dollar sales for 2003 are expected to drop by approximately 8 percent, as a recession in Lewis’s market is forecasted to continue at least through the first three quarters of the year. Total sales are forecasted to be 2,700 cartons. Lewis will be unable to raise its selling price from the 2002 level of $35.75. However, costs are expected to increase to $24.00 per carton for the whole year. Due to these cost/price pressures, the corporation wishes to lower its investment in inventory by holding only the essential inventory of 400 cartons at any time during the year. What is the effect of remaining on LIFO, assuming Lewis adopted LIFO in 2000? What method would you recommend now?

4).What is the LIFO reserve in 2000? What is the LIFO reserve in 2001? What is the significance of the LIFO reserve number? How much did the LIFO reserve increase in 2001? What is the significance of this increase?

5). Despite continuing inflation in the United States in the 1980s and 1990s many companies continued to use FIFO for all or part of their inventories. Why do you believe this was the case.

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Accepted Answer

1a. COGS = 56,930, 66,240, and 66,385 respectively; YE inventory = 21,620, 23,130, and 27,720 resepctively.
1b. COGS = 58,150, 67,320, and 67,600 respectively; YE inventory = 20,400, 20,830, and 24,205 respectively.
1c. COGS = 57,685, 66,246, and 66,513 respectively; YE inventory = 20,865, 22,369, and 26,830 respectively.
2. Tax savings= 488 for 2000, 432 for 2001, and 486 for 2002. Changing to LIFO will defer taxes given the current expectations.
3. The effect of remaining on LIFO in this situation is that pre-tax income for 2003 will be higher by $1,915 and, therefore result in higher tax for thie year of $766. That still results in a net deferral from inception.
4. LIFO reserve in 2000 = $1,220. LIFO reserve in 2001= $2,300. The LIFO reserve is the cumulative deferred income due to using LIFO instead of FIFO. The LIFO reserve increased by $1,080 in 2001. This reflects the income deferral for 2001.
5. There are a couple of reasons that some companies did not switch to LIFO. There are additional costs involved in computing LIFO inventory and maintaining the records necessary to substantiate the calculations for the IRS. In addition, there is a LIFO conformity rule - financial statements must reflect the same LIFO adjustments as the tax return. Because of that, switching to LIFO would cause the income reported on the financial statements to show a lower net income and many companies do not want to do that.