Switching from LIFO to FIFO

M. Potter is the manager of Masson Company. Potter receives an annual salary plus a bonus of 15 percent of net income before bonus and taxes. Masson Company uses the LIFO inventory costing method. During 2010 when prices were increasing, M. Potter switched to the FIFO inventory method.

Required:

Prepare an example that illustrates the effect on the income statement of switching from LIFO to FIFO.

In addition, show the effect of the switch on the balance sheet and the statement of cash flows.

A. Did net income increase or decrease?

B. Did ending inventory increase or decrease?

C. Did cash flows increase or decrease?

D. Could a change in inventory methods entitle M. Potter to a larger bonus than she was otherwise entitled to? Explain.

E. In this situation, was the change economically beneficial to the Masson Company? Explain.

Solution: