LIFO Reserve, FIFO Ending Inventory, and Deferred Taxes Explained | CFA Level 1 Exam Preparation

Understanding LIFO Reserve, FIFO Ending Inventory, and Deferred Taxes

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Question

A firm using LIFO accounting has a LIFO reserve of 4,700, with a FIFO ending inventory of 34,600. It is currently in the 40% tax bracket. If it switches to FIFO accounting for reporting purposes, it's deferred taxes ________.

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A. B. C. D.

C

When the firm switches from LIFO to FIFO, it must recognize the additional tax liability that arises because the taxes not paid in the past will now have to be paid.

This liability equals the LIFO reserve times the current tax rate and must be added to the deferred taxes account (to be completely accurate, you would have to go back all the way to the inception of the firm and recalculate historical taxes. This is never done).

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