Question

The choice among accounting principles often results in a trade-off between favoring valuations on the balance sheet over the income statement. For example, FIFO favors the balance sheet and LIFO favors the income statement. Some accountants argue that the inventory method used is irrelevant for financial reporting purposes so long as the user understands the impact of the choice of an inventory method. Is this true? Explain.

Answer 1

The accounting principles do often results in a trade-of between favoring valuations on the balance sheet over the income statement. So, there is a trade-off observed while using Inventory method.

Yes, the usage of the inventory method is irrelevant for the financial reporting purpose because:

1. Sooner or later all the inventory purchase prices are going to be included under Income Statement.

2. Using lower inventory rate towards will result in higher profit but the same will be squared up in coming time when higher inventory rate under FIFO method.

3. Under LIFO method, using current higher inventory rates will adjust the profits (at lower rate) on the present on-going market. The present sacrifice of profit will be compensated in later years with lower or prior inventory prices are included in Income Statement.

4. All the expenses expended by the concern on inventory constitutes of Inventory Expenses under Income statement and Balance of inventory on the closing Balance Sheet.

5. Using lower inventory rates in Income Statement will strengthen the Balance Sheet with higher is valued closing stock.

Thus, the use of Inventory valuation method is irrelevant and not so important than having a perfect treatment of the expenses and strengthening of Net Worth in balance sheet.

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