I had to read this and answer A,B,C, my answers are below please let me know if
ID: 2444666 • Letter: I
Question
I had to read this and answer A,B,C, my answers are below please let me know if they are correct and WHY. Or please let me know if they are incorrect and why you feel this way. Thank You
Reagen Wholesale Corp. uses the LIFO cost flow method. In the current year, profit at Reagen is running unusually high. The corporate tax rate is also high this year, but it is scheduled to decline significantly next year. In an effort to lower the current year’s net income and to take advantage of the changing income tax rate, the president of Reagen Wholesale instructs the plant accountant to recommend to the purchasing department a large purchase of inventory for delivery 3 days before the end of the year. The price of the inventory to be purchased has doubled during the year, and the purchase will represent a major portion of the ending inventory value.
What is the effect of this transaction on this year’s and next year’s income statement and income tax expense? Why?
If Reagen Wholesale had been using the FIFO method of inventory costing, would the president give the same directive?
Should the plant accountant order the inventory purchase to lower income? What are the ethical implications of this order?
What is the effect of this transaction on this year’s and next year’s income statement and income tax expense? Why?
In making a large inventory purchase in the current year using LIFO, especially when it represents a major portion of the company’s ending inventory, it would significantly lower their bottom line and thus their tax burden. In the next year, their bottom line will in turn be higher but due to the drastic decrease in the tax rate they will have less of a tax burden on their inventory then the prior year; this would result in a double windfall for the company.
If Reagen Wholesale had been using the FIFO method of inventory costing, would the president give the same directive?
If the company had been using FIFO instead, the president would have not recommended the same directive since, in doing so, it would cost the company more in the current year; next year they wouldn’t be taking full advantage of the tax break in regards to the inventory either.
Should the plant accountant order the inventory purchase to lower income? What are the ethical implications of this order?
While this wouldn’t be considered tax evasion, since they are not mispresenting their numbers illegally, it would be considered tax avoidance; both of which can be viewed as tax noncompliance and could be frowned upon by other companies and/or consumers. With that being said, on an ethical standpoint, the plant accountant should express to the president their concerns about the possible consequences the company could face with this decision from a public relations perspective; if the president still wants to go through with the decision then at least the accountant has done their due diligence.
Explanation / Answer
Part A)
The answer is correct. Explanation should be more in relation to the cost of goods sold and impact on net income. A purchase at higher prices would result in an increase in the cost of goods sold if the LIFO method is used. This would in turn lower the net income and reduce the tax burden of the company for the current year. The same logic would get applied if the prices continue to increase in the following year. In any case, the company would have to pay lower taxes because of the expected decrease in tax rate.
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Part B)
The answer is correct. Explanation should be more in relation to the cost of goods sold and increase in net income with the use of FIFO.
Use of FIFO would have resulted in lower cost of goods sold, as inventory purchased (earlier) at lower cost would have been sold first resulting in an increase in the net income, thereby, resulting in higher taxes for the current year. The same theory would apply to the next year (provided the prices continue to increase). Therefore, the president wouldnot have given the same directive, if the FIFO method had been put to use.
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Part C)
The answer posted is correct to some extent. However, it is important for the company to present the actual state of affairs to the stakeholders of the company. The financial statements are expected to provide a true and fair representation of the financial position of the company. Making huge purchases of inventory in order to hide profits and avoid tax can in no way be considered ethical, even if the management of the company is convinced about this approach. It is not only the plant accountant's responsibility to conduct an act of due diligence. False representations can result in lose of customer/investor confidence which can substantially affect the market reputation/goodwill of the company.
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