JKW Corporation (a fictional company) has been selling plumbing supplies since 1981. In 2003, the company adopted the LIFO method of valuing its inventory. The company has grown steadily over the years and a layer has been added to its LIFO inventory in each of the years the method has been used. The company’s inventory turnover ratio has averaged 4.5 in recent years. Management attempts to maintain a stable level of inventory at each store; the growth in inventory has been due to new stores being opened each year. In 20X1, the board of directors approved an incentive program that pays managers a sizable bonus in each year that certain performance targets are met. For 20X2, targeted earnings per share are $3.35. In an effort to track progress toward meeting this target, management produced the following income statement for the first nine months of 20X2.
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Income Statement |
|
|
January 1–September 30, 20X2 |
|
|
Sales |
$13,284,000 |
|
Cost of goods sold |
7,970,400 |
|
Gross margin |
5,313,600 |
|
Operating expenses |
2,391,120 |
|
Income before taxes |
2,922,480 |
|
Income tax expense |
613,721 |
|
Net income |
$ 2,308,759 |
|
Earnings per share (1,000,000 shares outstanding) |
$ 2.31 |
Based on past history, management expects 30% of the company’s annual sales to take place in the fourth quarter. Operating expenses and gross margin are expected to remain at 18% and 40% of sales, respectively, for the remainder of the year. The company’s tax rate is 21%.
Required:
1. Assuming that management maintains a stable level of inventory, project earnings per share for 20X2 based on the data provided.
2. Assume that you are JKW’s independent auditor, and your analysis indicates that projected earnings per share will fall short of the bonus target. In the past, JKW’s managers have used aggressive (and possibly unethical) behavior to achieve salary bonus targets. You suspect that the managers intend to deplete old LIFO layers deliberately in the fourth quarter. To help you detect such behavior, calculate the amount of the LIFO liquidation that would be needed in the fourth quarter to hit the EPS target in 20X2.
