E8-21 (LIFO Effect) The following example was provided to encourage the use of the LIFO method. In a nutshell, LIFO subtracts inflation from inventory costs, deducts it from taxable income, and records it in a LIFO reserve account on the books. The LIFO benefit grows as inflation widens the gap between current-year and past-year (minus inflation) inventory costs. This gap is: With LIFO Without LIFO Revenues $3,200,000 $3,200,000 Cost of goods sold 2,800,000 2,800,000 Operating expenses 150,000 150,000 Operating income 250,000 250,000 LIFO adjustment 40,000 0 Taxable income $ 210,000 $ 250,000 Income taxes @ 36% $ 75,600 $ 90,000 Cash flow $ 174,400 $ 160,000 Extra cash $ 14,400 0 Increased cash flow 9% 0% Instructions (a) Explain what is meant by the LIFO reserve account. (b) How does LIFO subtract inflation from inventory costs? (c) Explain how the cash flow of $174,400 in this example was computed. Explain why this amount may not be correct. (d) Why does a company that uses LIFO have extra cash? Explain whether this situation will always exist.