Question

Megall Company began operations on Jan. 1, YR1. For tax purposes, Megall has always used FIFO method of inventory method, and will continue to do so. For financial reporting purpose, Megall has used LIFO. During YR3, Megall decides to change from the LIFO to the FIFO method of inventory valuation. Had Megall always used the FIFO method, COGS would have been lower by $25,000 in YR1 and lower by $35,000 in YR2. The tax rate is 35% every year. Prepare the necessary journal entry Megall will record in YR3 when it changes from the LIFO to the FIFO method.

Fill in the blanks with either T (True) or F (False).  

1) Had Megall used FIFO, Inventory would have been higher by 15,000.
2) In YR1 and YR2, COGS on the Tax Book was higher.
3) This resulted in a deductible temporary difference.

Answer 1

As a result of change in method of inventory valuation from LIFO to FIFO , following are the consequences :

Year 1 : COGS would have been lower by $25000

Year 2 : COGS would have been lower by $35000

Cumulatively, we have claimed COGS in excess of $60000 and we have to pay Additional Tax of $ 21000 (60000 x 35% ) in this year.

1 . False

Reason : Had Megall used FIFO, Inventory would have been higher by 60,000 is correct.

2. True

Had Megall used FIFO, Inventory would have been higher by 25,000 in year 1 and 35,000 in year 2. Since Had Megall is using FIFO for Tax purposes, it means that the same was higher in tax returns also. So, the statement is True.

3.False

Tax differences arising as a result of Change in method of inventory are permanant tax differences and is not expected to reverse in upcoming tax periods. So, the given statement is false.

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