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NessaCPA

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Please explain the logic of a large purchase of inventory at end of year to reduce income. Lifo is used.?


Jim’s Music Company uses LIFO for inventory, and the company’s profits are quite high this year. The cost of inventory has been steadily rising all year, and Jim is worried about his taxes. You are Jim's accountant and you suggested that the company make a large purchase of inventory to be received during the last week in December. You explained to Jim that this would reduce his income significantly.

Jim still doesn’t understand the logic of your suggestion.
Explain how the purchase would affect taxable income.

Is this ethical? Jim is uncertain about the appropriateness of this from a legal and ethical perspective. Give your opinion and explain the ethical implications of making the purchase.

1482 day(s) ago

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Answers (2)

brandonm
The idea is prices usually always go up
inventory bough last will cost the most
with LIFO, you would use the last inventory first as you cost of goods sold, thereby reducing gross income
at the end of the year when you revalue your inventory, most of the inventory will be at the earliest or lowest costs, making cost of goods higher, and profit and taxes lower
would only increase income significantly if costs increased a lot and selling prices stayed the same = not realistic in the real world - nothing unethical about it - that's why the concept exists and the IRS allows it - if you ever get around to selling the business though, you may have to revalue inventory and take a loss, because buyer may deem LIFO inventory to be not representaive of actual costs

Posted 1482 days ago

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alohachris
1st - there is nothing unethical about this -
2nd - I question that it will really reduce his tax liability -
receiving the inventory - increases debt but does not reduce profits "unless" he also pays for the inventory before year end -
and even if he does - the inventory is booked as an asset and not an expense - effectively, the only thing he will do is to increase his payables - and unless he can burn through the inventory in short order his cash flow will suffer

Posted 1482 days ago

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Question Title Please explain the logic of a large purchase of inventory at end of year to reduce income. Lifo is used.?
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