It is currently December 31, 2013, the end of the fiscal year of The Should-I-Sw

Question

It is currently December 31, 2013, the end of the fiscal year of The Should-I-Switch Merchandising Co. The firm currently uses FIFO to value its inventory. Its beginning of year inventory was 12,000 units at a cost of $10 per unit. The firm purchased 16,000 units of inventory at $12 each on June 1, 2013 and 6,000 units at $15 each on December 1, 2013. 30,000 units of inventory were sold during the year. The firm's tax rate is 30%. The company will not pay any taxes it owes on income generated in 2013 until 2014.

If the firm continues to use FIFO its earnings after tax for the year would be $45,000. The end-of-year total assets would be $500,000.

Given that the manager wants to maximize the return on assets (earnings/total assets at end of year) for 2013, should he or she switch to LIFO?

Assuming that shareholders want to minimize the tax payments, would they want the firm to switch to LIFO?

Explanation / Answer

FIFo Date Units Price per unit Amount opening 12000 10 120000 1-Jun 16000 12 192000 1-Dec 6000 15 90000 Total 34000 Out of which 3000 were sold so left according to FIFO= 4000*15=$60000 If LIFO used than the ending inventory is 4000*10=$40000 Cost of Good sold as per FIFO(120000+192000+30000) 342000 Cost of Good sold as per LIFO(90000+192000+80000) 362000 So COGS is higher in LIFO so earning will be less and return on asset will be less so manager should opt FIFO Assuming the sales and purchases only, and profit given we will do calculation Sales A+B 387000 Sales A+B 387000 COGS A 342000 COGS A 362000 Profit in FIFO B 45000 Profit in LIFO B 25000 a) Return on Asset 0.09 0.05 FIFO is better b) For minimising the tax payment if cost is more than profit will be less and therefore tax payment will be less so can switch to LIFo

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