LIFO layers influence purchasing behavior and provide opportunity for income manipulation. Wilson Company sells chemical compounds made from expensium. The company has used a LIFO inventory flow assumption for many years. The inventory of expen- sium on December 31, Year 10, comprised 4,000 pounds from Year 1 through Year 10 at prices ranging from $30 to $52 per pound. Exhibit 7.14 shows the layers of Year 10 ending inventor}'.

EXHIBIT 7.14 WILSON COMPfiNY Layers of Year 10

(Problem 46)

Year-End Inventory Year Acquired Purchase Price per Pound Year 10 Year-End Inventory Pounds Cost Year 1 Year 6 Year 7 Year 10

$30 46 48 52 2,000 400 200 1,400 4,000

$ 60,000 9,200 19,200 72,800

$161,200 Expensium costs $62 per pound during Year 1 1, but the purchasing agent expects its price to fall back to $52 per pound in Year 12. Sales for Year 1 1 require 7.000 pounds of expensium.

Wilson Company wants to carry a stock of 4.000 pounds of inventory. The purchasing agent suggests that the firm decrease the inventory of expensium from 4,000 to 600 pounds by the end of Year 1 1 and replenish it to the desired level of 4,000 pounds early in Year 12.

The controller argues that such a policy would be foolish. If the firm allows inventories to decrease to 600 pounds, the cost of goods sold will be extraordinarily low (because Wilson will consume older LIFO layers) and income taxes will be extraordinarily high. The controller suggests that the firm plan Year 1 1 purchases to maintain an end-of-year inventory of 4.000 pounds.

Assume that sales for Year 1 1 do require 7.000 pounds of expensium. that the prices for Year 1 1 and Year 1 2 are as forecast, and that the income tax rate for Wilson Company is 40 percent.

a. Calculate the cost of goods sold and the end-of-year LIFO inventory for Year 1 1. assuming that the firm follows the controller's advice and that inventory at the end of Year 1 1 is 4,000 pounds.

b. Calculate the cost of goods sold and the end-of-year LIFO inventory for Year 1 1, assuming that the firm follows the purchasing agent's advice and that inventory at the end of Year 1 1 is 600 pounds.

c. Assume the firm follows the advice of the controller, not the purchasing agent. Calculate the tax savings for Year I 1 and the extra cash costs for inventory.

d. What should Wilson Company do? Consider quality of earnings and ethical issues in your response.

e. Management of Wilson Companj wants to know what discretion it has to \ar\ income for Year 1 I by planning its purchases of expensium. It' the tirm follows the controller's policy, aftertax income for Year 1 1 will be $50,000. What is the range, after taxes, of income that the firm can achieve by the purposeful management of expensium purchases.'