I had to read this and answer A,B,C, my answers are below please let me know if
ID: 2444662 • Letter: I
Question
I had to read this and answer A,B,C, my answers are below please let me know if they are correct and WHY. Or please let me know if they are incorrect and why you feel this way. Thank You
Reagen Wholesale Corp. uses the LIFO cost flow method. In the current year, profit at Reagen is running unusually high. The corporate tax rate is also high this year, but it is scheduled to decline significantly next year. In an effort to lower the current year’s net income and to take advantage of the changing income tax rate, the president of Reagen Wholesale instructs the plant accountant to recommend to the purchasing department a large purchase of inventory for delivery 3 days before the end of the year. The price of the inventory to be purchased has doubled during the year, and the purchase will represent a major portion of the ending inventory value.
What is the effect of this transaction on this year’s and next year’s income statement and income tax expense? Why?
If Reagen Wholesale had been using the FIFO method of inventory costing, would the president give the same directive?
Should the plant accountant order the inventory purchase to lower income? What are the ethical implications of this order?
A) The added inventory purchase would drive down the tax amount in the current year because the net income would be decreased. Next year the company would still likely benefit because the taxes would be paid at a lower rate.
B) The president probably wouldn't have given the same directive under FIFO because under FIFO the company would be responsible for more in taxes and would as a result have less cash.
C) I don't see any ethical reasons why the company shouldn't do the accountant shouldn't do this. As far as the laws go now there is nothing from preventing the company from doing this regardless of how unfair it may seem. The method is acceptable as long as it is followed across the board on financial reporting as well. The only negative is the tax break that these companies get.
Explanation / Answer
Answer to Question 1
Since a LIFO method of inventory is used, buying at a higher price would result in an increase of Cost of goods sold. So obviously the profit will go down and hence, tax too. But the decision to purchase 3 days before year end does not look like serving the purpose. The inventory purchased at a higher rate needs to be sold in order to utilise the cost against profit. In this case it has to be checked, whether the bulk purchase is sold off before year end. Otherwise, it will add to the closing inventory and the profit will be high.
Answer to Question 2
If a FIFO method was used, this decision should not have come up. Since, the inventory purchased in the beginning are sold first, this idea can benefit in increasing cost for the next year. But next year taxes are less. Hence, this idea will not be feasible.
Answer to Question 3
Ethically there are no restrictions in tax management. But increasing purchase would have other impacts susch as liquidity crunch at the time of payment for purchase. This could affect the shareholders value and concern them which leads to other consequences. Also a bulk purchase at the end of the yaer looks like a bogus purchase which might not look good to the auditors. If there are no controls in purchase, this method can also be used for fraudulent mtods to make personal gains. All these has to be considered.
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