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Inventory Valuation Methods and Ethical Considerations

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Inventory Valuation Methods and Ethical Considerations
Unit 4 Assignment 3
Dany St. Laurent
Capella University

Introduction
Generally accepted accounting principles (GAAP) are the measurements and disclosure rules used to develop the information in financial statements (Libby, Libby, Short. pg. 16). When reporting inventory, there are generally four inventory reporting methods used; Specific identification method, first-in, first-out method (FIFO), last-in, first out method (LIFO), and average cost method. Each method is in conformity with GAAP and the law. Also each method has their own implications during periods of inflation and deflation. They can also affect the net income results reported in the financial statement presentation. In this paper, I will assume the role of a manager and analyze the GAAP and ethical implications of three of the four reporting methods in a clothing store company.
First-In, First-Out Method
When FIFO is used, the goods that are purchased first are the first goods to be sold. The goods that are the newest are left in ending inventory. When a company deal with increasing inventory it provides lower cost of goods sold, and a higher income tax liability, but in the end a higher net income is acquired. For inventory with decreasing cost, this is used for both tax return and financial statements because it produces the lowest income tax payment. This is a good method if the companies good have a short shelf live. It allows the company to not have to throw away any goods assuming what is being reported is being practiced otherwise it is not only impractical but unethical as the company would be force to sell last season style at higher prices. This is also a benefit for managers because it may increase their compensation by reporting a higher net income.

Last-In, First-Out
When LIFO is used, the goods that are purchased last are the goods that are sold first. The goods that were purchased first are left in ending inventory. This is the method that is widely use in the U.S and it make sense from a pricing stand point. Your newest product or goods would be more valuable thus being able to be price at a higher profit margin. If for inventory with increasing cost, LIFO is used on tax return because it normally result in lower income taxes. It also provides higher cost of goods sold, but a lower net income. LIFO conformity rule states that if LIFO is used on the U.S. income tax return, it must also be used to calculate inventory and cost of goods sold for the financial statements (Libby, Libby, Short. Pg. 339). In a clothing store this might not make sense this reporting method would suggest we have old inventory that we could only get rid through sales because they would be out dated and it would not be profitable for the company.
Average Cost Method
The average cost method also known as weighted average cost method uses the weighted average unit cost of goods available for sale for both cost of goods sold and ending inventory (Libby, Libby, Short. pg. 337). This generally gives income and inventory amounts that are between FIFO and LIFO. This method make sense as a clothing company because you can assume a base value for all clothes in the store base on total volume and therefore would never run the risk of lower inventory value. This is not ethical because it will force the company to sell out dated fashion at current prices to balance its inventory value.
Manager’s Choice of Method
Methods only differ in the dollar amount of goods available for sale allocated to cost of goods sold versus ending inventory. The higher the ending inventory amount the lower the cost of goods sold and the higher the gross profit, income tax expense and income amount. As a manager I want to report higher earnings for my company and have my company pay the least amount of taxes and as late as possible allowed by the law. I would use FIFO because it would allow me to report higher earnings for my company even though I would have to pay a higher amount of income taxes.

References
Libby, R., Libby, P. A., & Short, D. G. (2014). Financial Accounting (8th ed.). New York:
McGraw-Hill.…...

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