The Bayside Company uses the LIFO cost flow method to value inventory. In the current year, profit at Bayside is running unusually high. The corporate tax rate is also high this year but it is scheduled to decline significantly next year. In light of this information, the president of Bayside instructs the purchasing department to make a large purchase of inventory for delivery 3 days before the end of the year. The price of the inventory to be purchased has doubled during the year.
QUESTION 1
What would be the effect of this transaction on this year’s net income?
a. The net income could increase.
b. The net income could decrease.
c. There would be no effect on net income
d. There is not enough information to determine if there would be an effect.
QUESTION 2
What would be the effect of this transaction on this year's income tax expense?
a. The income tax expense could increase.
b. The income tax expense could decrease
c. There would be no effect on income tax expense.
d. There is not enough information to determine if there would be an effect.
QUESTION 3
If Bayside had been using the FIFO cost flow method to value inventory instead of the LIFO cost flow method, would the president have given the same directive?
a. Yes, the president would have given the same directive. The effect on net income and the income
tax expense would have been the same.
b. Yes, the president would have given the same directive. There would have been no effect on net income or the income tax expense.
c. No, the president would not have given the same directive. There would have been an opposite effect on net income and the income tax expense.
d. No, the president would not have given the same directive. There would have been no effect on net income or the income tax expense.
QUESTION 4
The president's actions are an example of "earnings management." Which of the following statements about earnings management is false?
a. Earnings management is illegal.
b. Earnings management can sometimes have a negative side effect (e.g., the company may not be able to pay for the additional inventory).
c. Earnings management can sometimes be considered to be unethical.
d. None of these statements is false.
QUESTION 1
The effect of the transaction on this year's net income would be option a. The net income could increase. This is because under the LIFO cost flow method, the most recent purchases are the first to be recognized as expenses. By making a large purchase of inventory just before the end of the year, the company will be able to record this purchase at the higher, doubled price, which would increase the cost of goods sold and decrease the net income for the year.
QUESTION 2
The effect of the transaction on this year's income tax expense would be option a. The income tax expense could increase. Since profit is running unusually high this year, the higher net income resulting from the inflated cost of goods sold would also increase the taxable income, leading to a higher income tax expense.
QUESTION 3
If Bayside had been using the FIFO (First-In-First-Out) cost flow method instead of the LIFO method, the president would not have given the same directive. The effect on net income and the income tax expense would have been different. Under the FIFO method, the older, lower-priced inventory would be recognized as expenses first, so purchasing additional inventory at the higher price would not affect the cost of goods sold and hence, net income or income tax expense.
The answer is option d. No, the president would not have given the same directive. There would have been no effect on net income or the income tax expense.
QUESTION 4
The false statement about earnings management is option a. Earnings management is illegal. While earnings management practices can sometimes be considered unethical, it is not inherently illegal. However, certain manipulations may be considered fraudulent, such as intentionally misrepresenting financial statements or misleading investors and regulators. It is important for companies to maintain transparency and provide accurate financial information to stakeholders.
The answer is option a. Earnings management is illegal.
QUESTION 1: The effect of this transaction on this year’s net income would be a. The net income could increase. By purchasing inventory at the end of the year at a higher cost, the cost of goods sold (COGS) will be higher, reducing the net income.
QUESTION 2: The effect of this transaction on this year's income tax expense would be a. The income tax expense could increase. Since the profit is higher due to the higher COGS, the taxable income would also be higher, resulting in a higher income tax expense.
QUESTION 3: If Bayside had been using the FIFO cost flow method to value inventory instead of the LIFO cost flow method, the president would not have given the same directive. The correct answer is c. No, the president would not have given the same directive. There would have been an opposite effect on net income and the income tax expense. With FIFO, the older, lower-cost inventory would be sold first, resulting in lower COGS and higher net income.
QUESTION 4: The president's actions are an example of "earnings management." The statement that is false about earnings management is a. Earnings management is illegal. Earnings management is not always illegal but can sometimes be considered unethical, as stated in c. Earnings management can sometimes be considered to be unethical.