The inventory footnote from the Deere Companys 2005 10K fol

The inventory footnote from the Deere & Company\'s 2005 10-K follows ($ millions). Inventories Most inventories owned by Deere & Company and its United States equipment subsidiaries are valued at cost, on the \"last-in, first-out\" (LIFO) basis. Remaining inventories are generally valued at the lower of cost, on the \"first in, first-out\" (FIFO) basis, or market. The value of gross inventories on the LIFO basis represented 61 percent of worldwide gross inventories at FIFO value on October 31, 2005 and 2004, respectively, if all inventories had been valued on a FIFO basis, estimated inventories by major classification at October 31 in millions of would have been as follows. We notice that not all of Deere\'s inventories are reported using the same inventory costing method (companies can use different inventory costing methods for different inventory pools). What effect has the use of LIFO inventory costing had on Deere\'s tax liability for 2005 only (assume a 35% income tax rate)?

Solution

Some of the inventories of the company are valued at LIFO method, because under the LIFO method the inventories are valued at higher cost due to which lower profit is calculated and tax expense will also be decreased. If the inventories are purchased at lower prices than the cost of inventories comes to low cost. But in this case the cost of inventories at LIFO is lower than the cost of inventories at FIFO method of valuation. Therefore if the cost of inventories is at low price then the profit calculated will also be at low cost and low tax on profit.

The LIFO reserve for the two years 2004 and 2005 is calculated as under:

2004: ($1,002/$3,001)*100=33.39%

2005: ($1,132/$3,267)*100=34.65%

The LIFO reserve for the year 2005 have increased as compared to LIFO reserve at the year 2004 either because of price inflation or increased age of inventory.

Due to LIFO method of costing the inventories, the beginning inventory is shown at $1,999 and ending inventory has been valued at $2,135. Therefore the profit also effected by $136   ($2,135-$1,999). If profit increases by $136, then the tax on profit @ 35% amounts to $ 47.5 also increases in the year 2005. Therefore the tax on profit increases by the use of LIFO method.