Question

1) At the first joint meeting of the FASB, IASB and EASB (Endorian Accounting Standards Board) the controversy over inventory arose. The EASB allows LIFO and NIFO (next in first out) which values inventory at the price of acquiring the next unit. Their argument is that this is the minimum price at which the merchandise would be sold, and obsolete inventory would have no value. FASB allows LIFO but not NIFO and of course IASB does not allow either one. The US-IRS has stated that they will NOT change their policy regarding the requirement of LIFO for books if it is used for taxes, thus any removal of LIFO from GAAP would cause an increase in taxes for US Companies. For some unknown reason (maybe they listened to too much of Mr. Spock’s singing) they have come to you for advice. Should NIFO be allowed for financial accounting purposes why or why not? Should LIFO be allowed for financial accounting purposes why or why not? DEFEND your answer including the impact these methods have on income statements, taxes and balance sheets.

Answer 1

NIFO:

Next in first out (NIFO) is a method where the inventory is valued at the price at which the next unit is purchased. The argument of using NIFO is that the obsolete inventory shall be of no value and since the current price of each unit is considered to value inventory value reflects the actual value of inventory. NIFO has number of demerits including the fact that the inventory acquired earlier will be valued at higher prices that the amount paid to acquire such inventory. Thus, use of the method would result in overstatement of inventory. Hence, the method should not be allowed for financial accounting purposes.

LIFO:

Last in First out (LIFO) method uses a very unscientific method to value inventories by assuming that the latest purchases are issued to the production at the earliest leaving the earlier purchase in the inventory. Use of LIFO results in higher cost of production and low value of inventory thus, the net income under the method is often suppressed. Hence, LIFO should also not be sued for financial accounting as the method will not reflect the actual profit of an organization.

Observation:

Thus, none of the above method would help an organization to disclose correct amount of profit in the income statement. As a result of this taxes on such income will not be correctly determined and the inventory value to be stated in the Balance sheet would also not reflect the actual value of inventory as at the end of a financial period.