Analysis of disclosures from published financial reports on effects of changing from average cost to LIFO. Various disclosures from the annual reports of E. I.

duPont de Nemours & Company in the year it switched from average cost to LIFO for most of its inventories, as well as in the two following years, appear below. Assume an income tax rate of 34 percent.

Year 1 During the year. duPont changed its cost flow assumption for most of its inventories from average cost to LIFO to achieve a better matching of current costs with revenues.

Net income declined by $249.6 million, 27 percent, for the year.

Year 2 During the year, the firm reduced inventory quantities from the abnormally high levels at the start of the year This resulted in liquidation of LIFO inventory quantities carried at costs lower than those prevailing during the year Net income increased by approximately

$40.4 million.

Year 3 If the firm had valued inventory at current cost, rather than at historical cost using a LIFO cost flow assumption, the amounts on the balance sheet would have exceeded the amounts reported by $490 million at the end of the year and by $410 million at the beginning of the year

a. By how much did LIFO cost of goods sold in Year 1 differ from the amount computed with an average-cost cost flow assumption?

b. Why does a liquidation of LIFO layers, such as in Year 2, increase net income?

c. By how much did cost of goods sold for Year 2 differ from the amount that would have been reported had the layers not been liquidated? Give the amount and indicate whether this represents an increase or a decrease in cost of goods sold.

d. Why might the company not have reverted to average cost for Year 2?

e. Assume that an average-cost cost flow assumption gives ending inventory amounts that are approximately the same as cunent costs. Compute the Year 3 tax savings that resuhed from duPont's using LIFO rather than average cost.

f. Why might duPont choose an inventory cost flow assumption that reduces reported income?