Question

For each of the following situations, identify the inventory method that you would use or, given the use of a particular method, state the strategy that you would follow to accomplish your goal:

1. Inventory costs are increasing. Your company uses weighted-average cost and is having an unexpectedly good year. It is near year-end, and you need to keep net income from increasing too much in order to save on income tax.
2. Suppliers of your inventory are threatening a labour strike, and it may be difficult for your company to obtain inventory. This situation could increase your income taxes.
3. Inventory costs are decreasing, and your company’s board of directors wants to minimize income taxes.
4. Inventory costs are increasing, and the company prefers to report high income. e. Inventory costs have been stable for several years, and you expect costs to remain stable for the indefinite future. (Give the reason for your choice of method.)

Answer 1

a) The company should follow weighted average method. The company should carry only adequate inventory to meet its operational requirements. The inventory should not be increased higher than operational requirements (based on days on hand needed to ensure no stock out) since it will lead to higher net income and higher taxes for the year

b) LIFO method should be followed since due to strike the price of material is expected to go up. The Cost of goods sold will be higher in LIFO when prices are increasing and hence net income will be lower which will reduce the income taxes.

c) FIFO method should be followed since the earlier lot of higher purchase will be charged to cost of goods sold and closing inventory will be valued at lower prices which will lead to lower net income and lower income tax

d) FIFO method should be followed since inventory costs are increasing. The higher costs of purchase will be used for closing inventory valuation in FIFO method which will report higher income for the firm.