Question

Your boss has just contacted you about an inventory decision. It seems she is going to expand the business by selling products along with providing consulting services. Your boss' questions are emailed to you as follows:

• Which inventory costing method will provide the highest net income for the company?
• The company definitely plans to sell the oldest inventory first; does this affect the inventory costing method? Why?
• Are there any other considerations in making this decision?

Which method would you recommend and why?

Answer 1

1. FIFO inventory method will provide highest net income for the company. The FIFO method assumes that the oldest products in a company's inventory have been sold first. In inflationary environment this inventory method provides highest net income.

2. If company plans to sell the oldest inventory first then also FIFO method should be used. As this method assumes that the oldest products in a company's inventory have been sold first. So based on above we can say that this method of inventory valuation will be the best.

3. Consideration in making decision of inventory valuation method:

- Profitability : If company wants to show more profits then it can use FIFO method and if company wants to show least profits then it can use LIFO method.

- Stock sale sequence : If company firstly sells stock that is purchased first then FIFO method is preferred on the other hand if company firstly sells stock that is purchased last then LIFO method should be preferred.

- Comparability: Inventory valuation method can also depend on the type of industry in which they are to be used for comparability. For example, Pharma company will use FIFO method due to expiry date of medicines manufactured.

- Reporting standard : IFRS recognizes only FIFO and average inventory valuation method whereas US GAAP recognizes FIFO, LIFO and average inventory valuation method.

4. Based on company requirements FIFO is the most suitable inventory valuation method because it will result in highest net income for the company and will also recognize the oldest inventory sold first. Based on above discussion we can say that FIFO is best in this case.