Analyzing an Inventory Footnote Disclosure General Electric Company reports the

Question

Analyzing an Inventory Footnote Disclosure General Electric Company reports the following footnote in its 10-K report.

The company reports its inventories using the LIFO inventory costing method.

(a) What is the balance in inventories reported on GE's 2008 balance sheet?
$Answer(million)

(b) What would GE's 2008 balance sheet have reported for inventories had the company used FIFO inventory costing?
$Answer(million)

(c) What cumulative effect has GE's choice of LIFO over FIFO had on its pretax income as of year end 2008?

The cumulative effect is that pretax income has not changed. LIFO and FIFO are simply two different ways to account for inventories. Both methods lead to the same pretax income.

The cumulative effect on pretax income is nonexistent. The LIFO and FIFO methods of inventory accounting cause only cash flow effects, and they do not affect pretax income.

The cumulative effect is that pretax income has increased. FIFO matches more "current" inventory costs against current selling prices, thus avoiding the recognition of holding gains.

The cumulative effect is that pretax income has decreased. LIFO matches more "current" inventory costs against current selling prices, thus avoiding the recognition of holding gains.

(d) Assume GE has a 35% income tax rate. As of the 2008 year-end, how much has GE saved in taxes by choosing LIFO over FIFO method for costing inventory? (Round your answer to the nearest whole number.)
$Answer(million)

Has the use of LIFO increased or decreased GE's cumulative taxes paid?

decreased

increased

(e) What effect has the use of LIFO inventory costing had on GE's pretax income and tax expense for 2008 only (assume a 35% income tax rate)? (Round answers to the nearest whole number.)
2008 pretax income:

increased

decreased

by $Answer million.
2008 tax expense:

increased

decreased

by $Answer million.

December 31 (in millions) 2008 2007 Raw materials and work in process $ 8,710 $ 7,893 Finished goods 5,032 5,025 Unbilled shipments 561 539 14,303 13,457 Less revaluation to LIFO (706) (623) $ 13,597 $ 12,834

Explanation / Answer

a) The balance in inventories reported on GE's 2008 balance sheet is $13,597(million) using LIFO method.

b) GE's 2008 balance sheet have reported $14,303(million) for inventories had the company used FIFO inventory costing.

c) Cumulative pretax income (until the end of fiscal 2008) has been reduced by $706 million($14,303(million)- $13,597(million)) since GE adopted LIFO inventory costing. This is because LIFO matchesmore “current” inventory costs against current selling prices, thusavoiding the recognition of holding gains that would have resulted had FIFO inventory costing been used.The cumulative effect is that pretax income has decreased. LIFO matches more "current" inventory costs against current selling prices, thus avoiding the recognition of holding gains.

d) Pretax income has been reduced by $$706 million (see partc). Assuming a 35% tax rate,taxes have been reduced by $706× 0.35 = $247.1 million. Since adopting LIFO method, GE has saved $247.1million dollars in total taxes compared to taxes the company would have paid had it used the FIFO method all along.

e)For 2008 only, the LIFO reserve increased by $83 million ($706 million - $623 million).Consequently, 2008 pretax income is $83 million lower, relative to what it would have been with the FIFO method, thus decreasing taxes by $29.05 million ($83 million × 0.35). In fiscal 2008, the use of LIFO inventory costing saved taxes for GE. The taxes were not saved in prior years.

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