Question

Assuming the government does not eliminate LIFO, what are the ethical implications of a company switching its accounting policy from FIFO to LIFO, or the other way—from LIFO to FIFO? When and why would a company make this change? Explain your answer and discuss the financial statement effects.

Answer 1

The accounting method of last in, first out (FIFO) assumes that merchandise purchased last is sold first. With LIFO method the latest costs are moved to cost of goods sold and then this expense is more demonstrator of current prices. These costs are high during inflation thus the resulting gross profit and net income are lower. It helps the company to save tax dollars since payments are reduced. Thus the company would prefer to change from FIFO to LIFO when they want to show results at the end of the year with having the highest cash balance because the lower taxes would be paid on report of lower gross profit and net income. LIFO seems to be the better choice for the company during the inflation periods as it would better show the current cost of goods sold.

Under "FIFO" method the oldest inventory items are recorded as sold first however it does not necessarily mean that the exact oldest physical goods has been sold and tracked. FIFO method is a bit closer to actual physical flow of goods as mostly the companies sell goods in order in which they are produced or purchased. Also, the companies that choose the FIFO method will likely to have higher net income than those who choose the LIFO. the company would prefer to change from LIFO to FIFO when they want to take on higher taxes and profits during periods with inflation to show a more accurate inventory count.

Change from FIFO to LIFO method or the other wasy for inventory valuation purposes (retrospective application impractical) will require a change in accounting principle. There will be no restatement and base inventory will be taken as the opening inventory of the period of change