Chapter 8, Problem 6CA

To determine

Given: J Y, president of E Co., recently read an article that claimed that at least 100 of the country’s largest 500 companies were either adopting or considering adoption of the last-in first-out (LIFO) method for valuing inventories. The article stated that the firms were switching to LIFO to:

(1) Neutralize the effect of inflation in their financial statements,

(2) Eliminate inventory profits, and

(3) Reduce income taxes.

Ms. Y wonders if the switch would benefit her company. The company has a high inventory turnover rate, and inventories represent a significant proportion of the assets. Ms. Y has been told that the LIFO system is more costly to operate and will provide little benefit to companies with high turnover. She intends to use the inventory method that is best for the company in the long run rather than selecting a method just because it is the current fad.

(a)

To explain: What “inventory profits” are and how the LIFO method of inventory valuation could reduce them to Ms. Y.

To determine

(b)

To explain: The conditions that must exist for E Co. to receive tax benefits from a switch to the LIFO method, to Ms. Y.