Nixon Wholesale Corp. uses the LIFO cost flow method. In the current year, profit at Nixon is running unusually high. The corporate tax rate is also high this year, but it is scheduled to decline significantly next year. In an effort to lower the current year’s net income and to take advantage of the changing income tax rate, the president of Nixon Wholesale instructs the plant accountant to recommend to the purchasing department 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, and the purchase will represent a major portion of the ending inventory value.
Instructions
What is the effect of this transaction on this year’s and next year’s income statement and income tax expense? Why?
If Nixon Wholesale had been using the FIFO method of inventory costing, would the president give the same directive?
Should the plant accountant order the inventory purchase to lower income? What are the ethical implications of this order?
Post by classmate 1
What is the effect of this transaction on this year’s and next year’s income statement and income tax expense? Why?
By using a LIFO system of turning over the newest inventory first, the company records the highest cost of goods possible while holding the lowest cost of inventory. This method reports a lower net profit for the period. In this example, by buying this product at the end of the period, it will reduce the profit for the period by increasing the cost of goods sold and reduce the income taxes paid during the high tax period. Going into the next where these products will be sold, inventory will stay low as the expensive product is sold off first and any profits made will be taxed in the better tax rate of the next period.
If Nixon Wholesale had been using the FIFO method of inventory costing, would the president give the same directive?
Under FIFO the cost of goods sold is at its lowest. This is because the lower priced units from the beginning of the period sell first showing the cost of goods low while the newer more expensive material is counted in inventory. This method keeps the value of inventory higher and the cost per unit sold at its lowest. The downside of this is maximized profit reporting at the end of the period. The net income is recorded higher and increases income tax as the cost of goods sold is at a minimum. In the scenario it would not benefit the company to order the new materials as the new purchases will not change the cost of goods calculation.
Should the plant accountant order the inventory purchase to lower income? What are the ethical implications of this order?
It is unethical but not illegal in the United States. In this scenario it the company taking advantage of the tax laws and not paying their full potential. The benefit of LIFO is that the company keeps its profits lower and thereby minimizing income taxes. LIFO is an accounting preference that is optional for businesses in the United States. Both FIFO and LIFO have benefits to them. While LIFO reduces net profit, this can also be seen as a negative from potential business partners and investors. It comes down to the strategies of the company. The accountant should explain to the scenario to their leadership team and the possible perception of taking this action and proceed with the direction of his team.
Post by classmate 2
What is the effect of this transaction on this year’s and next year’s income statement and income tax expense? Why?
Effect on this year’s income statement and income tax expense:
Income Statement: The cost of goods sold (COGS) will increase significantly by the large purchase of inventory at the end of the year. This is because the LIFO method assumes that the most recently purchased inventory items are the first to be sold. Since the purchase is made when the inventory price has doubled, it will have a substantial impact on COGS and, consequently, net income.
Income Tax Expense: Lower net income will result in a lower taxable income for the current year, reducing the income tax expense. As the tax rate is high for the current year, the decrease in taxable income can help lower the overall tax burden.
Effect on next year’s income statement and income tax expense.
Income Statement: The large inventory purchase made at the end of the current year will increase the inventory value and carry over to the next year as part of the opening inventory. Consequently, the COGS for the next year will be lower, which may positively impact the net income.
Income Tax Expense: As mentioned earlier, the current year’s income tax expense will be lower due to the reduced net income. However, in the following year, when net income may increase due to the lower COGS, the income tax expense could potentially be higher if the tax rate remains unchanged.
If Nixon Wholesale had been using the FIFO method of inventory costing, would the president give the same directive?
The president may not give the same directive if the company had been using FIFO. FIFO assumes that the first items purchased are the first ones sold. In this case, a large purchase of inventory at the end of the year would not impact COGS significantly, as the items purchased at the higher price would be included in the ending inventory rather than being matched with sales. Therefore, the president might not see the same opportunity to reduce net income and income tax expense by making a large purchase at year-end.
Should the plant accountant order the inventory purchase to lower income? What are the ethical implications of this order?
Ordering the inventory purchase solely for the purpose of lowering income is ethically questionable. Such an action may be considered a form of income manipulation, as the intent is to artificially reduce net income for the purpose of minimizing tax liabilities. This could be seen as misleading to stakeholders, including shareholders, investors, and tax authorities. Engaging in such practices can undermine the integrity of financial reporting and violate accounting principles. It is important for accountants to uphold ethical standards, maintain transparency, and accurately represent the financial position of the company