Question

2.        The following note appeared in the 2018 annual report of Roca Company:

Inventories

	Inventories (in millions) at December 31 consisted of:					2018	2017
		Finished goods				$ 1,078.3	$     926.7
		Raw materials and work-in-process				716.2	684.7
		Supplies				78.0	65.6
		Total (approximates current cost)				$ 1,872.5	$ 1,677.0
		Reduction to LIFO cost				–	16.1
						$ 1,872.5	$ 1,660.9

Inventories valued at LIFO comprised approximately 44% and 42% of inventories at December 31, 2018 and 2017, respectively.

2-1.	What basis do you believe Roca uses to account for its inventories internally? WHY?
2-2.	Express your opinion as to why Roca reduces its inventories to LIFO cost.
2-3.	If Roca did not adjust its inventories to LIFO cost, what would be the impact on Roca’s
	a.	Net income before tax for 2017?
	b.	Retained earnings as of January 1, 2018 (assuming a 34% tax rate)?

Answer 1

2-1. The company has been using FIFO method of costing of inventories internally. This is due to reason because in the given question LIFO reserve is created to bring the inventory in line with LIFO method.

2-2. This is done so when financial statements are prepared using FIFO method but for tax preparation LIFO method is used because it increases COGS & reduce pre tax profits. The LIFO reserve comes about because most businesses use the FIFO, or standard cost method, for internal use and the LIFO method for external reporting, as is the case with tax preparation. This is advantageous in periods of rising prices because it reduces a company's tax burden when it reports using the LIFO method.

2-3. a) If LIFO reserve was not created then Closing Inventory would be of higher value and pre tax profit would rise by $16.1.

      b) Retained earnings would rise incrementally by 16.1*(1-0.34)=$10.63