Question

Golf Challenge Corp. is a retail sports store carrying golf apparel and equipment. The store is at the end of its second year of operation and is struggling. A major problem is that its cost of inventory has continually increased in the past two years. In the first year of operations, the store assigned inventory costs using LIFO. A loan agreement the store has with its bank, its prime source of financing, requires the store to maintain a certain profit margin and current ratio. The store’s owner is currently looking over Golf Challenge’s preliminary financial statements for its second year. The numbers are not favorable. The only way the store can meet the required financial ratios agreed on with the bank is to change from LIFO to FIFO. The store originally decided on LIFO because of its tax advantages. The owner recalculates ending inventory using FIFO and submits those numbers and statements to the loan officer at the bank for the required bank review. The owner thankfully reflects on the available latitude in choosing the inventory costing method. REQUIREMENTS: 1.How does Golf Challenge’s use of FIFO improve its net profit margin? 2.How does Golf Challenge’s use of FIFO improve its current ratio? 3.Is the action by Golf Challenge’s owner ethical? Explain and give at least 3 reasons from the material learned in Chapter 6 to support your answer. Please write one paragraph for each question.

Answer 1

A - FIFO method Use improve net Profit Margin

This is Possible only when there are continues rise in prices. In question also, it is said that cost of inventory is increasing from past 2 years. That is Prices are continously increasing.

In FIFO, Closing stock is the stock last Purchased. Hence cost of goods sold will relate to prices of old purchases which are lower. Lower cost of goods sold will result in Higher Profit Margin in Books.

B - use of FIFO improve Current Ratio

Since prices are continously increasing. Side by side, cost of inventory is continously increasing.

FIFO inventory is last purchased inventory which has higher prices.

Higher cost of Inventory will show higher Current Assets. And Higher Current Assets will improve Current Ratio

C - Ethical Action or Unethical Action

The change in the method of valuation should be clearly reported in financial statement with financial effects. Then it is ethical. If it is done to mislead the users with fraud purpose or it is changed without any purpose, then it will be unethica and Will breach consistency of financial reporting