Question

Company 1 and Company 2 are online retailers. Both companies are basically identical and follow the same accounting practices except that Company A uses LIFO and Company B uses FIFO to value their inventory. Because of rising inventory costs, both companies need additional capital to manage their operations.

For your main discussion post, reflect on these questions: If Company A and Company B apply for a loan at their local bank and the bank bases its decision on net income, which company is more likely to obtain the loan? Explain. What if the bank based its decision on cash flows associated with the inventory costing valuation method the company uses? Which company might be better positioned to obtain the loan? Elaborate your responses and provide an example as needed to support your assessment.

Answer 1

Company B

Company A FIFO

LIFO Units Rate Value Units Rate Value

Purchases 1000 32 32000 1000 32 32000

Purchases 800 34 27200 800 34 27200

Sale 1000 1000

Ending Inventory 800 800

ie. 800 32 25600 800 34 27200

Suppose,

Selling price/unit = 70

Total sale value

1000*70= 70000 70000

Less:COGS 800 34 27200 1000 32 32000

200 32 6400

Total COGS 33600 32000

Net Income 36400 38000

Company A uses LIFO to value inventory- ie. Sold finished goods are at the last-bought prices & so the COGS is higher & net income is lower.

Company B uses FIFO to value inventory- ie. Sold finished goods are at the first-bought prices & so the COGS is lower & net income is higher.

So, based on the above,

if the the bank bases its decision on net income,Company B ,using FIFO, is more likely to obtain the loan

if the bank bases its decision on cash flows associated with the inventory costing valuation method Company A ,using LIFO is more likely to be viewed favourably by the bank , as given the sales level, tax outflows are less because of the lower income.