RISING PRICES, A TIME TO SWITCH OFF LIFO?
The following information was taken directly from the annual report of a firm that wishes to remain anonymous. (The dates have been changed.)
FINANCIAL SUMMARY
Effects of LIFO Accounting
For a number of years, the corporation has used the last-in, first-out (LIFO) method of accounting for its steel inventories. In periods of extended inflation, coupled with uncertain supplies of raw materials from foreign sources, and rapid increases and fluctuations in prices of raw materials such as nickel and chrome nickel scrap, earnings can be affected unrealistically for any given year
Because of these factors, the corporation will apply to the Internal Revenue Service for permission to discontinue using the LIFO method of accounting for valuing those inventories for which this method has been used. If such application is granted, the LIFO reserve at December 31, 2011, of $12,300,000 would be eliminated, which would require a provision for income taxes of approximately $6,150,000. The corporation will also seek permission to pay the increased taxes over a 10-year period. If the corporation had not used the LIFO method of accounting during 2010, net earnings for the year would have been increased by approximately $1,500,000.
The 2011 annual report also disclosed the following:
2011 2010
1. Sales and revenues $536,467,782 $487,886,449
2. Earnings per common share $3.44 $3.58
Required:
a. The corporation indicates that earnings can be affected unrealistically by rapid increases and fluctuations in prices when using LIFO. Comment.
b. How much taxes will need to be paid on past earnings from the switch from LIFO? How will the switch from LIFO influence taxes in the future?
c. How will a switch from LIFO affect 2011 profits?
d. How will a switch from LIFO affect future profits?
e. How will a switch from LIFO affect 2011 cash flow?
f. How will a switch from LIFO affect future cash flow?
g. Speculate on the real reason that the corporation wishes to switch from LIFO.