ps4 - 15.501/516 Problem Set 4 Accounting for Inventory and...

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15.501/516 Problem Set 4 Accounting for Inventory and the Statement of Cash Flows I. Inventory Accounting 1. Assume the following facts: A firm has been operating for 4 years. Each year, it has manufactured 5 units of a single item, and sold 4; so at the end of year 4, there are 4 units in inventory. Production cost per unit was $3 in year 1, $4 in year 2, $5 in year 3, $6 in year 4. In year 5, production cost jumps to $10/unit. The firm again sells 4 units, but it manufactures only 1. This results in a liquidation of 3 units, i.e., to avoid liquidating old cost layers, the firm would have had to manufacture at least as many units as were sold (4), but instead it made only 1. a. What is the dollar value of the LIFO Reserve at the end of year 4? b. What is the dollar amount of the LIFO liquidation? I.e., how much lower is COGS in year 5 than if the firm had manufactured at least as many units (at $10/each) as it sold? c. What is the dollar amount of the LIFO reserve at the end of year 5? Hint: Your answer to part c. should indicate that the LIFO Reserve has increased during Year 5 despite the liquidation, AND that the liquidation effect is greater than the beginning LIFO Reserve value. d. Why do the relationships noted in the Hint above occur? e. What would COGS be in year 5 if the firm had always used FIFO rather than LIFO? How does COGS F IFO compare to COGS L IFO with and without the liquidation in year 5? f. Assuming a tax rate of 40%, how much additional income tax will the firm pay in year 5 because of the LIFO liquidation? II. Interpreting LIFO disclosures A note to the financial statements of Deere & Company reveals the following: Substantially all inventories owned by Deere & Company and it s
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