7-72 LIFO, FIFO, Purchase Decisions, and Earnings per Share

Kansas Seed Corn Supplies, a company with 100,000 shares of common stock outstanding, had the following transactions during 20X1, its first year in business:

Sales 1,000,000 pounds @ $5

Purchases 900,000 pounds @ $2 300,000 pounds @ $3

The current income tax rate is a flat 40%; the rate next year is expected to be 35%. It is December 20 and Brian Fleming, the president, is trying to decide whether to buy the 400,000 pounds he needs for inventory now or early next year. The current price is $4 per unit. Prices on inventory are expected to remain stable; in any event, no decline in prices is anticipated. Fleming has not chosen an inventory method as of yet, but will pick either LIFO or FIFO. Other expenses for the year will be $1.4 million.

1. Using LIFO, prepare a comparative income statement assuming the 400,000 pounds (a) are not purchased, and (b) are purchased. The statement should end with reported earnings per share.

2. Repeat requirement 1, using FIFO.

3. Comment on the preceding results. Which method should Fleming choose? Why? Be specific.

4. Suppose that in year 2 the tax rate drops to 35%, prices remain stable, 1.1 million pounds are sold @ $5, enough pounds are purchased at $4 so the ending inventory will be 800,000 pounds, and other expenses are reduced to $800,000.

a. Prepare a comparative income statement for the second year showing the impact of each of the four alternatives in year one (LIFO and FIFO with and without the late purchase) on net income and earnings per share for the second year.

b. Explain any differences in net income that you encounter among the four alternatives.

c. Why is there a difference in ending inventory values under LIFO, even though the same amount of physical inventory is in stock?

d. What is the total cash outflow for income taxes for the 2 years together under the four alternatives?

e. Would you change your answer in requirement 3 now that you have completed requirement 4? Why?