Question

Englehart Company sells two types of pumps. One is large and is for commercial use. The other is smaller and is used in residential swimming pools. The following inventory data is available for the month of March.

Accounting
(a) Assuming Englehart uses a periodic inventory system, determine the cost of inventory on hand at March

31 and the cost of goods sold for March under first-in, first-out (FIFO).

(b) Assume Englehart uses dollar-value LIFO and one pool, consisting of the combination of residential and commercial pumps. Determine the cost of inventory on hand at March 31 and the cost of goods sold for March. Assume Englehart’s initial adoption of LIFO is on March 1. Use the double-extension method to determine the appropriate price indices. (Hint: The price index for February 28/March 1 should be 1.00.) (Round the index to three decimal places.)

Analysis
(a) Assume you need to compute a current ratio for Englehart. Which inventory method (FIFO or dollar-

value LIFO) do you think would give you a more meaningful current ratio?

(b) Some of Englehart’s competitors use LIFO inventory costing and some use FIFO. How can an analyst compare the results of companies in an industry, when some use LIFO and others use FIFO?

Principles

Can companies change from one inventory accounting method to another? If a company changes to an inventory accounting method used by most of its competitors, what are the trade-offs in terms of the conceptual framework discussed in Chapter 2 of the textbook?

Answer 1

For accounting portion (a) and (b) could not be answered since details of inventory is not provided for calculation. However, for analysis portion answers are as Ollie's :-

(a). FIFO method would result in a more meaningful calculation of current ratio, it is because as per FIFO method the goods recently sold is the one which which has been purchased first and thus what is left in inventory is the one which has been purchased recently, which reflects the current picture. However, in case of LIFO method, which assumed that goods sold recently is the one which has been purchased recently and thus what is left in the inventory is there goods which had been purchased first which do not reflect the correct picture and thus, we can say that FIFO method would give a more meaningful current ratio.

(b) . Companies that uses LIFO method of valuation of inventory also reports LIFO reserve which is nothing but the difference between inventory value based on LIFO method with respect to inventory value based on FIFO method. Thus, by adding LIFO reserve to the value of inventory as per LIFO method we can get value of same inventory as per FIFO method and then analyst can easily make comparisonn as he will be having inventory values as per FIFO method for all the entities.

Principles

If a company changes method of valuation of inventory then it will amount to a change in accounting policy and thereby disclosures will be required in financial statements like company has to mention financial impact of the change in the notes to accounts .

Company is allowed to change accounting policy only in following cases :-

1 . Such change leads to better presentation of financial statements

2. Such change is required by law.

3 . Such change is in compliance with IFRS.