I know that COGS is lower under FIFO, therefore taxes are Higher and NI is higher than LIFO. If NI is higher under FIFO, how can cash flow be lower under FIFO? The book says its because higher taxes are paid out but i still don’t get it with NI being higher. Is this relating to the statement of cashflows?
just because your net income is higher doesn’t necessarily mean that your cash flow is greater… no matter if you use fifo or lifo, this situation is still the same. you’re still going to sell the same amount of widgets and have the same number of widgets in your inventory. the difference lies in the reporting. in times of rising prices, your net income is going to be higher with fifo (cheaper goods that came in the beginning are in your cogs). when you report your income under fifo, you’re saying your net income is higher. thus, your taxes are going to be higher. THIS is where the CASH difference comes into play. you’re paying out CASH for taxes. with lifo, your net income is lower and you pay out less CASH in taxes. thus, the situation on the business end is the same but the cash paid out is different. make sense?
Cash Flow OPERATIONS is lower under FIFO than LIFO.
My comments from another thread also apply here: Some confusion arises when one tries to compare these kinds of numbers because: 1) Are we comparing the results of using one method over another method(s)? If so, which methods? In the above example, the questions states that “…is considering several alternative methods of depreciation for long-term assets”, therefore it is clear we are comparing double-declining method of depreciation with all other methods. 2) Are we looking at the pure impact of using the method on the company’s results? That’s what lead me (erroneously) to accept saurya_s’s observation on assets rising because of increasing earnings, leading to higher assets (i.e., higher cash and/or accounts receivable). We should not look at the impact on the firm’s financials in isolation because we don’t know the revenue year over year…we don’t know other costs, etc. When comparing with other methods, we don’t need to know revenue and expenses because they are the same under all methods, regardless of what they are. We may some times look at the pure impact of adopting a particular strategy, but not in these kinds of problems on depreciation, FIFO/LIFO, operatig lease/capital lease, etc. And if so, we will have to be provided with revenue/expense projections. Anyone agrees?
aren’t taxes taken out before NI? Is there something between the Income statement and the statement of cashflows that i’m missing here?
> If NI is higher under FIFO, how can cash flow be lower under FIFO? Yes, taxes are taken out before NI. If your NI is high, wouldn’t your taxes be high? When your taxes are high, isn’t your cashflow lower than if your taxes were low?
Another way of saying it, is this: If NI is higher (than LIFO), then your pretax income is higher (than LIFO), therefore your taxes are higher (than LIFO), which means your cashflow is lower (than LIFO). *** read the two lines above aloud, and you recognize how silly CFA candidates really are.
I think where I’m getting confused is…if FIFO has larger taxes taken out of NI, how is NI still higher than for LIFO?
net income and cash flow are two different things
don’t confuse CFO and the Income statement
> I think where I’m getting confused is…if FIFO has larger taxes taken out of NI, > how is NI still higher than for LIFO? Not giving up on you… FIFO LIFO Sales $1000 $1000 ُDepreciaiion 400 600 Pre tax income $600 $400 taxes (50%) 300 200 NI $300 $200 So, with FIFO you pay $300 in taxes, but only $200 under LIFO, right? NI under FIFO is larger ($300 versus $200). So, if you pay higher taxes it does not mean you report lower earnings. If I pay income taxes more than you do, does that mean my annual income has to be less than yours?