LIFO layers influence purchasing behavior and provide opportunity for income manipulation. Wilson Company sells chemical compounds made from expensium. The company has used a LIFO inventory flow assumption for many years. The inventory of expensium on December 31, 2008, comprised 4,000 pounds from 1999 through 2008 at prices ranging from $30 to $52 per pound:

Expensium costs $62 per pound during 2009, but the purchasing agent expects its price to fall back to $52 per pound in 2010. Sales for 2009 require 7,000 pounds of expensium. Wilson Company wants to carry a stuck of 4,000 pounds of inventory. The purchasing agent suggests that the firm decrease the inventory of expensium from 4,000 to 600 pounds by the end of 2009 and replenish it to the desired level of 4,000 pounds early in 2010.
The controller argues that such a policy would be foolish. If the firm allows inventories to decrease to 600 pounds, the cost of goods sold will be extraordinarily low (because Wilson will consume older LIFO layers) and income taxes will be extraordinarily high. The controller suggests that the firm plan 2009 purchases to maintain an end-of-year inventory of 4,000 pounds.
Assume that sales for 2009 do require 7,000 pounds of expensium, that the prices for 2009 and 2010 are as forecast, and that the income tax rate for Wilson Company is 40%.
a. Calculate the cost of goods sold and the end-of-year LIFO inventory for 2009, assuming that the firm follows the controller's advice and that inventory at the end of 2009 is 4,000 pounds.
b. Calculate the cost of goods sold and the end-of-ear LIFO inventory for 2009. Assuming that the firm follows the purchasing agent's advice and that inventory at the end of 2009 is 600 pounds.
c. Assume the firm follows the advice of the controller, not the purchasing agent. Calculate the tax savings for 2009 and the extra cash costs for inventory.
d. What should Wilson company do? Consider quality of earnings issues in your response.
e. Management of Wilson Company wants to know what discretion it has to vary income for 2009 by planning its purchases of expension. If the firm follows the controller's policy, after-tax income for 2009 will be $50,000. What is the range, after taxes, of income that the firm can achieve by the purposeful management of expensiumpurchases?

Transcribed Image Text:

Year Acquired Purchase Price Pounds Cost 2,000 200 $ 60,000 1999 S30 2004. 2005. 46 9,200 19,200 400 48 2008. Total. 52 1,400 4,000 72,800 $161,200