Question

Why do we have so many methods for accounting for inventory? How does this impact comparability of financial statements of different companies? In your opinion, should companies be allowed to use accounting methods that are inconsistent with the physical flows of inventory? Explain.

Answer 1

Hello,

Basing on the above question,the following answers were given:

1. Why do we have so many methods for accounting for inventory?

Various factors influence the companies to decide the methods of accounting for inventory to be followed.They might be:

**Desire to show better profit picture.

**Desire to increase cash flows through reduction in income taxes.

**Requirement by Financial Accounting Standards Board to change accounting methods.

** Desire to follow industry practices.

** When you buy inventory from suppliers, the price tends to change over time, so you end up with a group of the same item in stock, but with some units costing more than others. As you sell items from stock, you have to decide on a policy of whether to charge items to the cost of goods sold that were presumably bought first, or bought last, or based on an average of the costs of all items in stock.

** The reason is that inventory measurement bears directly on the determination of income! The slightest adjustment to inventory will cause a corresponding change in an entity’s reported income.

2.How does this impact comparability of financial statements of different companies?

Financial statements of one entity must also be consistent with other entities within the same line of business. This should aid users in analyzing the performance and position of one company relative to the industry standards.

For example an investor wants to invest in a particular industry say as automobile industry.If two different companies use different accounting policies it is difficult to the investors or stakeholders to compare those two companies on a single basis.

3. In your opinion, should companies be allowed to use accounting methods that are inconsistent with the physical flows of inventory?

In my opinion companies should not be allowed to follow accounting methods that are inconsistent with the physical flows of inventory because:

Generally, companies use the inventory method that best fits their individual circumstances. However, this freedom of choice does not include changing inventory methods every year or so, especially if the goal is to report higher income. Continuous switching of methods violates the accounting principle of consistency, which requires using the same accounting methods from period to period in preparing financial statements. Consistency of methods in preparing financial statements enables financial statement users to compare statements of a company from period to period and determine trends. If we switch inventory methods, we must restate all years presented on financial statements using the same inventory method.

Thank You......