Why does a company that uses lifo have extra cash

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Reference no: EM131139629

LIFO Effect The following example was provided to encourage the use of the LIFO method.

In a nutshell, LIFO subtracts inflation from inventory costs, deducts it from taxable income, and records it in a LIFO reserve account on the books. The LIFO benefit grows as inflation widens the gap between current-year and past-year (minus inflation) inventory costs. This gap is:

 

With LIFO

Without LIFO

Revenues

$3,200,000

$3,200,000

Cost of goods sold

2,800,000

2,800,000

Operating expenses

150,000

150,000

Operating income

250,000

250,000

LIFO adjustment

40,000

0

Taxable income

$  210,000

$  250,000

Income taxes @ 36%

$   75,600

$   90,000

Cash flow

$  174,400

$  160,000

Extra cash

$  14,400

0

Increased cash flow

9%

0%

Instructions

(a) Explain what is meant by the LIFO reserve account.

(b) How does LIFO subtract inflation from inventory costs?

(c) Explain how the cash flow of $174,400 in this example was computed. Explain why this amount may not be correct.

(d) Why does a company that uses LIFO have extra cash? Explain whether this situation will always exist.

Reference no: EM131139629

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