Firm X wants to raise $10 million to grow and attract new investors. Firm X operates in an inflationary environment and has been using the LIFO inventory valuation method to minimize their net earnings and thereby reduce their taxes. The CEO asks you to estimate the change in net earnings that would happen if they switched to FIFO.

After reviewing Firm Xs finances, you estimate that pre-tax income would increase by $1.2 million if the company adopted the FIFO method. However, the switch would result in approximately $400k of additional taxes. The overall effect would result in an increase of $800k in net earnings. The CEO tells you to prepare the tax return on a LIFO basis for inventory, but to prepare statements on a FIFO basis to be sent to potential investors.

1. How will the switch to FIFO affect the Balance Sheet?
2. What are the legal and ethical implications of the CEOs recommendation?
3. If you switch to FIFO for taxes as well as financial reporting purposes, net income will increase by $800k. Comment on the possibility of paying $400k in income taxes to obtain an additional $800k of net income.