Part a. A company may compute inventory under one of various cost flow assumptions. Among these assumptions are first-in, first-out (FIFO) and last-in, first-out (LIFO). In the past, some companies have changed from FIFO to LIFO for computing portions or all of their inventory.

Required

1. Ignoring income tax, explain what effects a change from FIFO to LIFO has on a company’s net earnings and working capital.

2. Explain the difference between the FIFO assumption of earnings and operating cycle and the LIFO assumption of earnings and operating cycle.

Part b. A company using LIFO inventory may establish a “Reserve for the Replacement of LIFO Inventory” account.

Required

Explain why and how a company establishes this “reserve” account and where it should show the account on its statement of financial position.