Question

Cansela Corporation reports inventory and cost of goods sold based on calculations from a LIFO periodic inventory system. The company began 2021 with inventory of 7,000 units of its only product. The beginning inventory balance of $88,000 consisted of the following layers:
  

2,500 units at $10 per unit	=	$	25,000
4,500 units at $14 per unit	=		63,000
Beginning inventory		$	88,000

  
During the three years 2021–2023 the cost of inventory remained constant at $16 per unit. Unit purchases and sales during these years were as follows:
  

	Purchases	Sales
2021	17,500	19,500
2022	23,000	25,500
2023	19,500	21,000

  
Required:
1. Calculate cost of goods sold for 2021, 2022, and 2023.
2. Disregarding income tax, determine the LIFO liquidation profit or loss, if any, for each of the three years.
3. Determine the effects of LIFO liquidation on cost of goods sold and net income for 2021, 2022, and 2023. Cansela’s effective income tax rate is 25%.
  

Answer 1

1. Cost of goods sold:

2021

Cost of Goods sold =17,500 units @$16

+2,000 units @14

=$280,000+$28,000=$308,000

2022

Cost of Goods sold =23,000 units @$16

+2,500 units @14

=$368,000+$35,000=$403,000

2021

Cost of Goods sold =19,500 units @$16

+1,500 units @14

=$312,000+$21,000=$333,000

2. Disregarding income tax, determination the LIFO liquidation profit or loss, if any, for each of the three years:

2021

Unit included in cost of goods sold are 2,000 units from beginning inventory purchased at $14 that have now been liquidated.

If the company had purchased at least 19,500 units, no liquidation would have occurred. Then cost of goods sold would have been = 19,500 Units@$16=$312,000 instead of $308,000.

The difference between these two cost of goods sold=$312,000-$308,000= $4,000 which is the before tax LIFO liquidation profit.

2022

Unit included in cost of goods sold are 2,500 units from beginning inventory purchased at $14 that have now been liquidated.

If the company had purchased at least 25,500 units, no liquidation would have occurred. Then cost of goods sold would have been = 25,500 Units@$16=$408,000 instead of $403,000.

The difference between these two cost of goods sold=408,000-403,000= $5,000 which is the before tax LIFO liquidation profit.

2023

Unit included in cost of goods sold are 1,500 units from beginning inventory purchased at $14 that have now been liquidated.

If the company had purchased at least 21,000 units, no liquidation would have occurred. Then cost of goods sold would have been = 21,000 Units@$16=$336,000 instead of $333,000.

The difference between these two cost of goods sold=$336,000-$333,000= $3,000 which is the before tax LIFO liquidation profit.

3.  Determination the effects of LIFO liquidation on cost of goods sold and net income for 2021, 2022, and 2023. Cansela’s effective income tax rate is 25%:

2021

Net effect of the liquidation is to increase net income

=4,000(1-25%)=$3,000

If the company decided to purchase an additional 4,000 units at $ 16 per unit during the year.

Income tax currently would be saved= 4,000(16-14)25%=$2,000.

2022

Net effect of the liquidation is to increase net income

=5,000(1-25%)=$3,750

If the company decided to purchase an additional 5,000 units at $ 16 per unit during the year.

Income tax currently would be saved= 5,000(16-14)25%=$2,500.

2023

Net effect of the liquidation is to increase net income

=3,000(1-25%)=$2,250

If the company decided to purchase an additional 3,000 units at $ 16 per unit during the year.

Income tax currently would be saved= 3,000(16-14)25%=$1,500.