A firm using LIFO accounting has a LIFO reserve of 600, with a LIFO ending inventory of 4,900. It is currently in the 40% tax bracket. If it switches to FIFO accounting, it's equity ________.
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A. B. C. D.C
The presence of a LIFO reserve implies that by following LIFO, the firm has been able to deduct higher COGS from gross income than under FIFO (remember that
LIFO reserve equals inventory value under FIFO minus inventory value under LIFO and this will be positive when the COGS under FIFO is lower than that under
LIFO). thus, the retained earnings (and hence equity) is understated by LIFO Reserve*(1 - tax rate). Therefore, when the firm switches from LIFO to FIFO, the equity is increased by 600*(1 - 0.4) = 360.