The controller of Sagehen Enterprises believes that the company should switch from the LIFO method to the FIFO method. The controller’s bonus is based on the next income. It is the controller’s belief that the switch in inventory methods would increase the net income of the company. What are the differences between the LIFO and FIFO methods?
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Solution
For understanding whether the controller of the Sagehen Enterprises is going to make any wise switch from the existing LIFO method to FIFO method, it is highly important for understanding the methods and the effect that these have on the company. These are inventory methods which are based on the assumptions that aid in the valuation of inventory when it is sold. The company Sagehen Enterprises is currently using the LIFO method. The inventory method of Last In First Out is based on the assumption that the goods which are brought in last are sent out first. It is preferred by the companies as it decreases the income on which the taxes can be assessed because of the production of lower profits in a period with rising prices (Wainwright, et al., 2012).
The First-in-First-out method, on the other hand, assumes that the first item brought should be the first item sold. The example of such method would be that the goods like meat and milk. FIFO and LIFO have thus some differences (Kimmel, Weygandt, & Kieso, 2010). The FIFO is based on the chronological purchasing order whereas the other inventory valuation method is based on the reverse order of purchasing. The FIFO method is naturally easier to have and track record of. However, the LIFO creates difficulty because of the market price and inventory costs. Both incomes from both methods are only temporary and when the inventory has completely liquidated the difference in the income will equal out (Wainwright, et al., 2012). The main differences occur in the final income and balance statement. As the company is based on the net income, the FIFO method is the most appropriate one while assuming that the company does not mind any higher taxes. The LIFO method is also not a good ending inventory indicator as the inventory left can be obsolete. Furthermore, it also leads to lower net income with higher cost of goods sold. Therefore, FIFO is certainly the better option for the company (Weygandt, Kimmel, & Kieso, 2015).
References
Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2010). Accounting: Tools for Business Decision Making (4 ed.). John Wiley & Sons.
Wainwright, S., Ganim, C., Galuardi, P., Ralling, D., Moneypenny, D., Wilson, L., . . Purcell, K. (2012). Principles of Accounting: Volume I. Bridgepoint Education,
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & Managerial Accounting. John Wiley & Sons.
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