One of the CFAI EOC question make this statement.
"The cash ratio (cash and cash equivalents ÷ current liabilities) would be lower because cash would have been less under FIFO. " Can anyone explain to me how cash is affected by the adjustment? My understanding is INventory and COGS are affected.
And COGS affects income before taxes, which affects taxes, which affects cash.
Under FIFO (with rising costs), COGS is lower, taxable income is higher, taxes paid is higher, cash is lower.
Bob’s your uncle.
Got it. Thanks.
Great!
My pleasure.
It is obvious to me that earning before taxes must be higher under FIFO. Along with it higher taxes, sure. But taxes are a percentage of EBT, and as long as the tax rate is constant and <100%, I can not end up with less Net Income than I would have if I have an increased EBT. Therefor why is my cash lower?? The way it is stated it sound like: “The more money you earn, the less cash you’ll have”
I really don’t get it
Assuming increasing inventory costs, yes.
To be clear: taxes you pay in cash.
Nobody’s saying that you’ll have less net income with a higher EBT.
Because your net income is higher, so you’re paying more income tax. In cash.
It’s not about how much you earn; it’s about how you account for the costs on what you earn. If you show higher costs, then you’ll pay less in tax, and have more cash.
The only difference in cash flows between FIFO and LIFO is the amount of (cash) taxes you pay; if you pay less in tax, you end up with more cash.
Alright, understood! So it is really just about the cash on hand.
And we do not assume that the higher NI will translate into cash?
Also many thanks for the quick response!
My pleasure.