Tax effects we have seen that both inventory on the

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TAX EFFECTS We have seen that both inventory on the balance sheet and net income on the in- come statement are higher when companies use FIFO in a period of inflation.Yet, many companies have selected LIFO.Why? The reason is that LIFO results in the lowest income taxes (because of lower net income) during times of rising prices. For example, at Houston Electronics, income taxes are $750 under LIFO, com- pared to $990 under FIFO. The tax savings of $240 makes more cash available for use in the business. H E L P F U L H I N T A tax rule, often referred to as the LIFO conformity rule , requires that if companies use LIFO for tax purposes they must also use it for financial reporting pur- poses. This means that if a company chooses the LIFO method to reduce its tax bills, it will also have to report lower net income in its financial statements. PDF Watermark Remover DEMO : Purchase from to remove the watermark
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Using Inventory Cost Flow Methods Consistently Whatever cost flow method a company chooses, it should use that method consis- tently from one accounting period to another.This approach is often referred to as the consistency principle , which means that a company uses the same accounting principles and methods from year to year. Consistent application enhances the comparability of financial statements over successive time periods. In contrast, us- ing the FIFO method one year and the LIFO method the next year would make it difficult to compare the net incomes of the two years. Although consistent application is preferred, it does not mean that a com- pany may never change its inventory costing method. When a company adopts a different method, it should disclose in the financial statements the change and its effects on net income. Illustration 6-14 shows a typical disclosure, using informa- tion from financial statements of Quaker Oats (now a unit of PepsiCo ). 262 Chapter 6 Inventories Illustration 6-14 Disclosure of change in cost flow method QUAKER OATS Notes to the Financial Statements Note 1: Effective July 1, the Company adopted the LIFO cost flow assumption for valuing the majority of U.S. Grocery Products inventories.The Company believes that the use of the LIFO method better matches current costs with current revenues.The effect of this change on the current year was to decrease net income by $16.0 million. Is LIFO Fair? Exxon Mobil Corporation , like many U.S. companies, uses LIFO to value its inventory for financial reporting and tax purposes. In one recent year, this resulted in a cost of goods sold figure that was $5.6 billion higher than under FIFO. By increasing cost of goods sold, Exxon Mobil reduces net income, which reduces taxes. Critics say that LIFO provides an unfair “tax dodge.” As Congress looks for more sources of tax revenue, some lawmakers favor the elimination of LIFO. Supporters of LIFO argue that the method is conceptually sound because it matches current costs with current revenues. In addition, they point out that this matching provides protection against inflation.
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