Question

how Fed monetary policy impacts business decisions regarding the inventory method used by the organization. Relate your response to issues impacting financial reporting.

Answer 1

To understand how the Federal Reserve's policy on interest rates affects business, you should first realize what the Fed is trying to do. The goals of Fed monetary policy are (1) support sustainable growth in the U.S. economy, (2) support high employment and (3) keep prices stable. The Fed accomplishes these goals through managing the amount of money in circulation and in accounts at commercial banks. One of the Fed's tools for managing money is to change interest rates. High interest rates make money more expensive and contract the amount of money in circulation and in banks. Low rates make money less expensive and increase the money supply.

Now lets understand the two methods of inventory accounting, i.e., LIFO (Last-in-first-out) and FIFO (First-in-first-out). The method of inventory accounting a business chooses can directly impact its balance sheet, income statement, and statement of cash flows. Not only do companies have to track the number of items sold, but they have to track the cost of each item. These two methods both have a different effect on a company's financial statements.

1. LIFO assumes that the last items put on the shelf are the first items sold. Last-in, first-out is a good system to use when your products are not perishable or at risk of quickly becoming obsolete. Under LIFO, when prices rise, the higher priced items are sold first and the lower priced products are left in inventory. This increases a company's cost of goods sold and lowers its net income, both of which reduce the company's tax liability.
2. FIFO, on the other hand, assumes that the first items put on the shelf are the first items sold, so your oldest goods are sold first. This system is generally used by companies whose inventory is perishable or subject to quick obsolescence. If prices go up, FIFO will give you a lower cost of goods sold because you are using your older, cheaper goods first. Your bottom line will look better to your banker and investors, but your tax liability will be higher because you have a higher profit.

Now that we have understood the role of Fed and the inventory accounting methods used by business; we can say that the inventory accounting method used by a firm during a financial year is totaly based on the monetary policy stance taken by the Fed.