Many companies on LIFO are occasionally faced with strikes or material shortages that necessitate a reduction in their normal inventory levels to satisfy current sales demands. A few years ago, several large steel companies requested special legislative relief from the additional taxes that ensued from such events.
A news story stated the following:
As steelworkers slowly streamed back to the mills this week, most steel companies began adding up the tremendous losses imposed by the longest strike in history. At a significant number of plants across the country, however, the worry wasn€™t losses but profits€”"windfall€ bookkeeping profits that for some companies may mean painful increases in corporate income taxes.
These outfits have been caught in the backfire of a special mechanism for figuring up inventory costs on tax returns. It€™s known to accountants as LIFO, or last in, first out. Ironically, it€™s designed to slice the corporate tax bill in a time of rising prices. Biggest Bite€”Most of the big steel companies€”16 out of the top 20€”as well as 40 percent of all steel warehousers, use LIFO accounting in figuring their taxes. But the tax squeeze from paper LIFO profits won€™t affect them all equally. It will put the biggest bite on warehousers that kept going during the strike€”and as a result, the American Steel Warehouse Assn. may ask Congress for a special tax exemption on these paper profits. Companies such as Ryerson and Castle have been caught because they have had to strip their shelves bare in order to satisfy customer demands during the strike. And they probably won€™t be able to rebuild their stocks by the time they close their books for tax purposes.
To see how this situation can happen, consider the following example. Suppose a company adopted LIFO in 1976. At December 31, 20X8, its LIFO inventory consisted of three €œlayers€:

In 20X9, prices rose enormously. Data follow:

A prolonged strike near the end of the year resulted in a severe depletion of the normal inventory stock of 190,000 units. The strike was settled on December 28, 20X9. The company intended to replenish the inventory as soon as possible. The applicable income tax rate is 40%.
1. Compute the income taxes for 20X9.
2. Suppose the company had been able to meet the 500,000-unit demand out of current purchases. Compute the income taxes for 20X9 under thosecircumstances.

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From 1976 110,000 units $1.00 $110,000 55,000 From 1978 30,000 units @ 1.20 36,000 $201,000 From 1977 50,000 units1.10 500,000 unlts @ $3.00- Sales Purchases Operating expenses $1,500,000 340,000 units @ $2.00$ 680,000 $500,000