The use of FIFO means the company is assuming that the oldest inventory will be sold first. This means that the older inventory is cheaper than the more recent things added to inventory. These older inventory items are used to value the cost of goods sold and in an environment where the price is rising, this results in a lower cost of goods sold. If the cost of goods sold is low, then there will be a higher net profit margin. FIFO will result in an improved net profit margin.
Current ratio is calculated by dividing current assets by current liabilities. Inventory is part of the assets section on the balance sheet. Using FIFO increases the current assets when reporting higher prices for newer added inventory. Any increase in current assets results in a higher and improved current ratio.
Switching from LIFO to FIFO is not ethical due to the LIFO conformity rule. This rule states that if a company uses LIFO for tax purposes, then the IRS requires the company to use LIFO for financial and tax reporting. Before switching to FIFO, the owner of Golf Challenge Corp. used LIFO for tax advantages. Switching to FIFO goes against the LIFO conformity rule and is therefore not ethical.
Golf Challenge Corp. is a new business which is at the end of its second year of business. During the first year of business, they used the LIFO method to report their gross profit and net income. However, due to rising costs, Golf Challenge Corp. changed to the FIFO method for their ending inventory. They felt that this change would benefit their loan they have with their bank. This change will improve its net profit margin and current ratio by yielding a higher gross profit margin and net income ( Shaw & Wild, 2021).
The decision to switch from LIFO to FIFO is not ethical. Golf Challenge Corp. used LIFO for the tax advantages. Due to the LIFO conformity rule, the IRS requires businesses to also use LIFO for financial reporting (LB&I). When Golf Challenge Corp. decided to change their accounting method, they also broke one of the core principles of GAAP. The Principle of Consistency is not being followed due to the change of methods (CFI Team). Going forward, Golf Challenge Corp. will need to continue to use FIFO for their financial reporting. This will help them stay consistent and will prove that they are not trying to hide any losses they might have with their inventory.
Ethical Challenge Discussion Post
Course Code: Course Name
Ethical Challenge Discussion Post
Response to Discussion 1
In your discussion, you have explained the effect FIFO has on a company's inventory and how using FIFO helps improve the net profit margin. Also, more detail of its effect on the cost of goods sold, since the first inventory goes out first, lowering the cost of goods with increased inventory prices in the market. From the discussion, we get more informed on how inventory affects the current ratio since the current ratio includes current assets, and the balance sheet shows the inventory being part of the current ratio (Azahra et al.,2022). Therefore, using FIFO ensures an improved current ratio.
A clear explanation of the conformity rule doesn’t allow corporations to switch to FIFO and LIFO for their own personal benefit. The discussion clearly shows that the owner of Golf Challenge Corp acted against the conformity rule, and we can see he did this to benefit the company since a clear explanation is seen of how FIFO benefits a company.
Response to Discussion 2
In your discussion, we understand the Golf Challenge Corp business and what made the corporation change to FIFO as a valuation method for their assets due to the rise in prices. Also, we understand why the valuation method's quick shift is wrong due to the conformity and consistency rules under the generally accepted accounting principles (Conley et al.,2019).In the discussion, we can get information on what the company should do to avoid the GAAP problem on the consistency and conformity rules.
In conclusion, both discussions are informative and helpful in understanding how FIFO affects assets valuation method, net profit, and current ratio.
Azahra, A., & Siauwijaya, R. (2022). Selection of Inventory Valuation Method Using Fifo and Weighted Averaged. Business Economic, Communication, and Social Sciences (BECOSS) Journal, 4(1), 11-22.
Conley, K., Natarajarathinam, M., Lu, W., & Rangan, S. (2019). Effect of accounting policies on effectiveness of inventory management strategies. Engineering Management Journal, 31(4), 246-256.
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