a physical inventory on december 31 shows 2,000 units on hand. holliday sells the units for $12 each. the company has an effective tax rate of 20%. holliday uses the periodic inventory method. what is the difference in taxes if LIFO rather than fifo is used?
To calculate the difference in taxes based on the LIFO (Last-In, First-Out) inventory method compared to the FIFO (First-In, First-Out) method, we need to determine the cost of goods sold (COGS) under each method.
Under the periodic inventory system, the cost of goods sold is calculated by subtracting the cost of ending inventory from the sum of the cost of goods available for sale and the beginning inventory. We'll assume there is no beginning inventory in this case:
COGS = Cost of Goods Available for Sale - Ending Inventory
Since the information provided does not mention the specific details of the company's purchases and their costs during the year, we'll make some assumptions for the sake of the example. Let's say the company purchased 5,000 units throughout the year, and the cost per unit varied as follows:
- First purchase: 1,000 units at $10 per unit
- Second purchase: 3,000 units at $11 per unit
- Third purchase: 1,000 units at $13 per unit
Now, let's calculate the COGS for each method and determine the difference in taxes:
1. LIFO Method:
Using LIFO, the most recent purchases (last in) are considered as sold first. So, the first purchase made will be assumed to be the amount of the ending inventory.
Ending inventory = 1,000 units (First purchase: $10 per unit)
COGS = (5,000 units - 1,000 units) * $13 per unit
= 4,000 units * $13 per unit
= $52,000
Taxable Income = Revenue - COGS
Assuming revenue = units sold * selling price
Units sold = Ending Inventory
Revenue = 1,000 units * $12 per unit
= $12,000
Taxable Income = $12,000 - $52,000
= -$40,000
Since the taxable income is negative, there will be no taxes payable. The difference in taxes, in this case, would be the tax savings of $0.
2. FIFO Method:
Using FIFO, the first purchases made (first in) are considered as sold first. So, the most recent purchases will be assumed to be the amount of the ending inventory.
Ending inventory = 2,000 units (Third purchase: $13 per unit)
COGS = (5,000 units - 2,000 units) * $10 per unit
= 3,000 units * $10 per unit
= $30,000
Taxable Income = Revenue - COGS
Assuming revenue = units sold * selling price
Units sold = (5,000 units - 2,000 units)
Revenue = (5,000 units - 2,000 units) * $12 per unit
= 3,000 units * $12 per unit
= $36,000
Taxable Income = $36,000 - $30,000
= $6,000
Tax Payable = Taxable Income * Effective Tax Rate
= $6,000 * 20%
= $1,200
The difference in taxes between using LIFO and FIFO methods would be the tax payable under FIFO minus the tax savings under LIFO:
Difference in taxes = Tax Payable (FIFO) - Tax Savings (LIFO)
= $1,200 - $0
= $1,200
Therefore, using the FIFO method instead of the LIFO method would result in a difference in taxes of $1,200.