Suppose you are the controller of a manufacturing company that currently used the FIFO method of accounting for inventory. Also, suppose the economy is currently experiencing a period of high inflation. Although profits are higher this year than last year, you realize that the cost to replace inventory is also higher. You are considering changing accounting methods from FIFO to LIFO. What factors should you consider before making a change? Answer this question on one paragraph with at least one source APA.
For this module’s discussion you are to assume the position of the controller of a company that sells inventory, and you are in a high inflationary period. While profit for the year seems to be higher than that of the previous year, inventory replacement cost has gone up due to the high inflation. The decision confronting you is to determine appropriate inventory valuation method to apply based on the rising cost of replacing inventory so as to save on taxes. You are considering going along with LIFO for inventory valuation but are apprehensive of the fact that when inventory prices will decline, LIFO will not be the appropriate valuation method for inventory, as it will result in higher taxes. You are to weigh the factors affecting the situation carefully and then make a decision as to whether to use LIFO and recommend your option.
Answer this question on one paragraph with at least with at least 7 sentence and one source APA.
Then, respond to two of your classmates’ postings in any of the following ways:
- Build on something your classmate said
- Explain why and how you see things differently
- Share an insight from having read your classmate’s posting
- Offer and support an opinion
- Expand on your classmate’s posting
The respond should be one short paragraph with at least 7 sentence.
When dealing with inventory there is first in first out (FIFO) and last in first out (FIFO). In other term LIFO assumes the most recent item in inventory is going to be the first sold. Doing inventory this way is going to have a higher tax advantage, “During times of inflation, LIFO results in a higher cost of goods sold and a lower balance of remaining inventory. A higher cost of goods sold means lower net income, which results in a smaller tax liability.” (Dopuch 1988)
During inflation FIFO has the effect of increasing the value of remaining inventory and increasing net icome. This would help trying to get potential investors and lenders showing a large assets and income.
A problem with using LIFOB type of inventory is that you can have older inventory that never leaves the warehouse will get out dates or expired and no one will want to buy. Iphones and bread are two examples that can be used, If customer grab bread that was last put out ( further expiration date) the items that were put there a couple days ago will keep getting older. They will reach a point where it has to be thrown out and the company is losing out on inventory that is not being purchased. Same things goes for iphones, as the newer phones get released customers stop buying the older phones and eventually they get sent back to apple.
Based on this circumstance with the economy and the high inflation I would suggest to switch to the LIFO method for tax purposes.
Dopuch, N., & Pincus, M. (1988). Evidence on the choice of inventory accounting methods: LIFO versus FIFO. Journal of Accounting Research, 28-59.
First, we’ll need to understand the trade-off between LIFO and FIFO and how it will affect net income, COGS, and inventory costs, before making any changes. Second, we need to see what our objective is and what we want to accomplish from each method. For example, to increase net income, reduce inventory cost, or etc. So, if we are currently experiencing a high rate of inflation, it’s likely that prices for goods and services has also risen. To help the company reduce inventory cost we might want to use the LIFO method. This method will allow us to sell all the latest items purchased for COGS at a higher rate, in terms, reduces inventory cost, but lower net income at the end of the year. However, with the FIFO method, it will allow us to cost the earliest or oldest items purchased for COGS at a lower rate. Therefore, when inflation causes prices on goods and services to increases, the cost of inventory also increases leaving us with a higher inventory cost, but also higher net income too.
Edwards, J. D. & Hermanson, R. H. (n.d). Accounting Principles: A Business Perceptive. Retrieved From: https://courses.lumenlearning.com/sac-finaccounting/chapter/effects-of-inventory-method-on-the-financial-statement/