Larry Inc. and Farry Inc. are two trading (merchandize) firms that are identical
ID: 2554928 • Letter: L
Question
Larry Inc. and Farry Inc. are two trading (merchandize) firms that are identical in every respect-the only difference between the two firms is that Larry follows LIFO whereas Farry follows FIFO to account for inventory. Both face a corporate income tax rate of 30%. Financial statements of Larry are presented below. All figures are in dollars. Dec 31, 2001 30,000 30,000 35,000 95,000 Dec 31, 2002 20,000 20,000 60,000 100,000 Dec31,2003 Dec 31,2000 10,000 10,000 25,000 45,000 Assets Cash Inventory Other Assets Total Assets Liabilities and Equity Liabilities Capital Stock Retained Earnings Total Liabilities and Equity LIFO Reserve 25,000 50,000 75,000 150,000 20,000 15,000 10,000 45,000 50,000 15,000 30,000 95,000 45,000 15,000 40,000 100,000 85,000 20,000 45,000 150,000 Zero 15,000 10,000 40,000 For calendar year 2001, Larry reported net income of $25,000 and total cost of purchases of merchandize inventory $50,000 For calendar year 2002, Larry reported net income of $15,000 and COGS of $40,000. For calendar year 2003, Larry reported dividends of $5,000. (a) What was Farry's 2001 COGS? (b) What was Farry's 2002 net income? (c) What is Farry's retained earnings balance on Dec 31, 2003?Explanation / Answer
(a) Calculate Farry's 2001 COGS:
Larry follows LIFO method and Farry follows FIFO method.
COGS of Larry under LIFO method in 2001=Beginning inventory+Purchases made during the year-Ending Inventory
=$10,000 (December 31, 2000)+$50,000-$30,000(December 31, 2001)
=$30,000
COGS of Farry under FIFO method in 2001=COGS of Larry under LIFO method+Beginning LIFO reserve- Ending LIFO reserve
=$30,000-+$0(December 31, 2000)-$15,000(December 31, 2001)
=$15,000
Hence, Farry's 2001 COGS is $15,000.
(b) Calculate Farry's 2002 net income.
COGS of Larry under LIFO method in 2002=$40,000
COGS of Farry under FIFO method in 2001=COGS of Larry under LIFO method+Beginning LIFO reserve- Ending LIFO reserve
=$40,000+$15,000(December 31, 2001)-$10,000(December 31, 2002)
=$45,000
Hence, COGS of Farry under FIFO method ($45,000) is greater than COGS of Larry under LIFO method($40,000) by an amount of $5,000. ($45,000-$40,000). When COGS increases it decreases the net income.
Tax rate is 30%.
Earnings before interest and tax rate=Amount×(1-tax rate)
=$5,000×(1-0.3)
=$5,000×0.7
=$3,500
Therefore, net income of Farry will be $3,500 less than the net income of Larry.
Net income of Farry in 2002=Net income of Larry in 2002-$3,500
=$15,000-$3,500
=$11,500
Hence, Farry's 2002 net income was $11,500.
3.
Calculate Farry's retained earnings balance on December 31, 2003.
Farry's retaind earnings under FIFO in 2003=Larry's retaind earnings under LIFO in 2003-Dividends in 2003+(Ending LIFO reserve×(1-tax rate))
=$45,000-$5,000+($40,000×(1-0.3))
=$40,000+(40,000×0.7)
=$68,000
Hence, Farry's retained earnings balance on December 31, 2003 is $68,000.
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