Question

Question: In January 2017, Susquehanna Inc. requested and secured permission from the commissioner of the Internal Revenue Service to compute inventories under the last-in, first-out (LIFO) method and elected to determine inventory cost under the dollar-value LIFO method. Susquehanna Inc. satisfied the commissioner that cost could be accurately determined by use of an index number computed from a representative sample selected from the company’s single inventory pool.

Instructions

(a) Why should inventories be included in (1) a balance sheet and (2) the computation of net income?

(b) The Internal Revenue Code allows some accountable events to be considered differently for income tax reporting purposes and financial accounting purposes, while other accountable events must be reported the same for both purposes. Discuss why it might be desirable to report some accountable events differently for financial accounting purposes than for income tax reporting purposes.

(c) Discuss the ways and conditions under which the FIFO and LIFO inventory costing methods produce different inventory valuations. Do not discuss procedures for computing inventory cost.

Short answer

Inventory is shown in two places in books of accounts due to computing net income and total assets. Different inventory method gives different revenue and tax expense and thus gives different inventory valuation.

Step-by-step solution

Inventory in the balance sheet and net income

The inventory for any business is divided into two portions—sold inventories and inventory on hand. The cost of sold inventories is calculated to determine gross profit. So, the cost of goods sold is recorded in the income statement,

The residual inventories or the inventories on hand are not the cost for the business but are a kind of asset that a company holds for a short period of time. Thus those residual or closing inventories should be presented in the balance sheet.

So, in this way inventories are included in both the income statement and balance sheet.

Different accountable events for tax reporting

Accounting is based on different assumptions and estimations. Some estimations drive more net income while some less. Although all the assumptions and estimations are correct in their own way.

So under different estimations and assumptions, the same accounting event puts a different effect on the income statement and financial position.

From a business point of view, an owner will adopt an assumption that reflects higher income and good financial position but from the government and tax point of view, the assumption that fetches less income and lower financial position would be adopted.

Thus Internal Revenue Code allows the adoption of that assumption and estimations that is advantageous from both points of view.

Condition for the difference in inventory valuation under LIFO & FIFO

The following are the conditions for the difference under the two methods –

i) Rising pricing trend

ii) LIFO Liquidation

iii) Deferrals of income tax in LIFO

iv) Kinds and nature of inventory