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# Choosing LIFO or FIFO for inventory

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I would like someone to check my math and methodologies related to the following problem and identify any errors in my methodology and thought process. Here is the data:

Purchased \$600,000 in 2000.
Purchased \$3,000,000 during 2001. Operating expenses (excluding management bonuses) are \$400,000, and sales are \$6,000,000.

The management compensation agreement provides for incentive bonuses totaling 1% of after-tax income (before bonuses). Taxes are 25%, and accounting a taxable income will be the same.

The company is undecided about the selection of the LIFO or FIFO inventory methods. For the year ended 2001, ending inventory would be \$700,000 and \$1,000,000 respectively under LIFO and FIFO.

Questions:
1. Evaluate management's incentives to choose FIFO.
Management will receive a larger bonus using the FIFO methodology. They
will also show a larger net income that raises their earnings per share.
2. Evaluate management's incentives to choose LIFO.
Their taxes will be lower.

I have attached my calculations, however, I believe there is something wrong with them as it was my understanding from reading my textbook that LIFO creates a lower book income, but cash flows are higher, therefore the reaction in the security market is an increase in the stock price. But according to what I calculated cash flow is not higher. Thanks.

#### Solution Preview

What you have done is correct. Purchases in 2000 are \$600,000 which you have taken as opening inventory for 2001. That is an assumption to be mentioned and in the absence of ...

#### Solution Summary

The solution explains the impact of LIFO or FIFO method on net income

\$2.49