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Trystdy12
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Posted: 20 Sep 2009 at 16:20 | IP Logged  

Drew Co. uses the average cost inventory method for internal reporting purposes and LIFO for financial statement and income tax reporting.  At December 31, 1992, the inventory was $375,000 using average cost and $320,000 using LIFO.  The unadjusted credit balance in the LIFO Reserve account on December 31, 1992, was $35,000.  What adjusting entry should Drew record to adjust from average cost to LIFO at December 31, 1992?

Debit Credit
a.Cost of Goods Sold$55,000 Inventory$55,000

b.Cost of Goods Sold$55,000 LIFO Reserve$55,000

c.Cost of Goods Sold$20,000 Inventory$20,000

d.Cost of Goods Sold$20,000 LIFO Reserve$20,000

Answer is D

Why is LIFO reserve account getting credited here?

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bryris
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Posted: 20 Sep 2009 at 17:02 | IP Logged  

The company keeps its books based on the average cost method. However, it prepares taxes based on the LIFO method. Since its books are on the average cost basis, it must make an adjustment to the accounts (kept on this basis) to restate them to LIFO just to prepare the returns. Remember, they aren't actually changing methods, just temporarily adjusting to the reportable method.

Accordingly, per the books, inventory is 375,000. It should be (what you won't know in the real world) 320,000 based on LIFO. The balance in the LIFO reserve account (merely a valuation account, not unlike any other contra- account) is 35,000. Thus, the current LIFO balance is 375,000 - 35,000 = 340,000. You need to "devalue" the inventory by another 20,000 to hit the 320,000.

The entry is:

CGS 20,000
   LIFO reserve 20,000

The inventory account is now:

375,000 - 55,000 = 320,000 <--- LIFO method info to report on tax return.

In real life, it would seem that this entry would need to be reversed or that these entries would be made in a separate area. For example, cut and paste the trial balance into a separate system and make the tax adjusting entries there. Someone with more experience than me on this might want to comment.


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CPA N2009
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Posted: 21 Sep 2009 at 09:15 | IP Logged  

bryris wrote:
In real life, it would seem that this entry would need to be reversed or that these entries would be made in a separate area. For example, cut and paste the trial balance into a separate system and make the tax adjusting entries there. Someone with more experience than me on this might want to comment.

FYI - In real life the $5,000,000 + client that I have that uses this, keeps the liability on the books as a liability and each year we adjust it to the correct amount off set to an expense account.



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