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Chapter 8: Q19Q. (page 422)

In an article that appeared in the Wall Street Journal, the phrases “phantom (paper) profits” and “high LIFO profits” through involuntary liquidation were used. Explain the sephrases.

Short Answer

Expert verified

Phantom profit is a result of FIFO inventory in an inflationary period. Involuntary liquidation is the result of layer reduction of base year reduction.

Step by step solution

01

Phantom (paper) profits

Phantom (paper) profit is the result of using the FIFO method during an inflationary period. In the FIFO method, ending inventory is valued at recent prices, and COGS is valued at historical prices. So during the inflation period, COGS seems to be very low. As a result, the profits are overvalued, and it is reflected only as a paper profit and not a real profit.

02

 Step 2: High inventory profits through involuntary liquidation

This is the problem that happens when the LIFO base year or layer is forcibly reduced. The LIFO base or layer is reduced due to the reduction in ending inventory at base cost in the subsequent year. Thus, as a result, irrelevant and old costs are matched with the current revenues leading to the problem of net income distortion.

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Most popular questions from this chapter

Question:Data for Amsterdam Company are presented in BE8-4. Compute the April 30 inventory and the April cost of goods sold using the LIFO method.

Question:Johnny Football Shop began operations on January 2, 2017. The following stock record card for footballs was taken from the records at the end of the year.

Units Unit Invoice Gross Invoice

Date Voucher Terms Received Cost Amount

1/15 10624 Net 30 50 \(20 \)1,000

3/15 11437 1/5, net 30 65 16 1,040

6/20 21332 1/10, net 30 90 15 1,350

9/12 27644 1/10, net 30 84 12 1,008

11/24 31269 1/10, net 30 76 11 836

Totals 365 $5,234

A physical inventory on December 31, 2017, reveals that 100 footballs were in stock. The bookkeeper informs you that all thediscounts were taken. Assume that Johnny Football Shop uses the invoice price less discount for recording purchases.

Instructions

(a) Compute the December 31, 2017, inventory using the FIFO method.

(b) Compute the 2017 cost of goods sold using the LIFO method.

(c) What method would you recommend to the owner to minimize income taxes in 2017, using the inventory informationfor footballs as a guide?

Oasis Company has used the dollar-value LIFO method for inventory cost determination for many years. The following data were extracted from Oasis’ records.

Price Ending Inventory Ending Inventory

Date Index at Base Prices at Dollar-Value LIFO

December 31, 2017 105 \(92,000 \)92,600

December 31, 2018 ? 97,000 98,350

Instructions

Calculate the index used for 2018 that yielded the above results.

Why should inventories be included in (a) a statement of financial position and (b) the computation of net income?

Geddes Corporation is a medium-sized manufacturing company with two divisions and three subsidiaries, all located in the United States. The Metallic Division manufactures metal castings for the automotive industry, and the Plastic Division produces small plastic items for electrical products and other uses. The three subsidiaries manufacture various products for other industrial users.

Geddes Corporation plans to change from the lower of first-in, first-out (FIFO)-cost-or market method of inventory valuation to the last-in, first-out (LIFO) method of inventory valuation to obtain tax benefits. To make the method acceptable for tax purposes, the change also will be made for its annual financial statements.

Instructions

(a) Describe the establishment of and subsequent pricing procedures for each of the following LIFO inventory methods.

(1) LIFO applied to units of product when the periodic inventory system is

used.

(2) Application of the dollar-value method to LIFO units of product.

(b) Discuss the specific advantages and disadvantages of using the dollar-value LIFO application as compared to specific goods LIFO (unit LIFO). (Ignore income tax considerations.)

(c) Discuss the general advantages and disadvantages claimed for LIFO methods.
See all solutions

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