Crow Corporation has used the LIFO inventory method for the past 10 years. During that time, the prices Crow pays for the inventory have increased by 50%. Its inventory value when it first adopted LIFO was $5,000,000. The company began using a just-in-time inventory system the same year it adopted LIFO, and although sales have increased, the quantities of goods on hand at year end has not changed in the past ten years. The corporation's marginal tax rate has been 35% in all of the years. As a result of the LIFO election:
A)The company has deferred $5,000,000 of income tax.
B)The company has deferred $1,750,000 ($5,000,000 × .35) of income tax.
C)The LIFO election did not defer any income tax because the quantity of goods on hand has not changed.
D)The company has deferred $875,000 [(.50)($5,000,000)(.35)] of income tax.
E)None of the above.

Question

Quizplus · Accepted Answer

The LIFO method assumes that the most recently acquired inventory items are sold first, which means that the inventory on hand consists of older, lower-priced items. As the prices of inventory have increased over the years, the LIFO method results in a lower cost of goods sold and higher ending inventory values. This, in turn, leads to higher profits and higher income taxes in times of inflation. However, because the company has not changed the quantities of goods on hand in the past ten years, the LIFO election did not result in a change in inventory values, and therefore, there was no deferral of income tax. Instead, the company has deferred income tax on the unrealized LIFO reserve, which is the difference between the reported inventory value under LIFO and the inventory value that would have been reported under FIFO (the first in, first out method). The deferral of income tax is equal to the unrealized LIFO reserve multiplied by the marginal tax rate. In this case, the deferred income tax is $875,000 [(.50)($5,000,000)(.35)].

Crow Corporation Has Used the LIFO Inventory Method for the Past