You are a Senior Managerial Accountant at Wild Water Sports Inc., a company that makes water sporting equipment. Currently the company uses the LIFO method to value inventory costs. Your boss has asked you to look into the advantages and disadvantages of switching to FIFO or the Weighted Average method. Course objectives covered: 1,2,5 PROJECT REQUIREMENTS: This project is due in Week 3 of the course. Required: Prepare a 2-3 page memo explaining the advantages and disadvantages of LIFO, FIFO, and the weighted average method. Include the financial statement implications of switching from LIFO to each of the other valuation methods. Finally, make a recommendation based on your research as to which valuation method Wild Water Sports, Inc. should use.

Memorandum

Date: May 24, 2019

To:	Wild Water Sports Management
From:	Senior Managerial Accountant
Subject:	Effective Valuation Method

 

Inventory accounting is a fundamental aspect for Wild Water Sports Inc. and the inventory management toolkit as it enables the organization to scrutinize the value of products sold and ultimately, the profitability. There are different inventory evaluation strategies including LIFO, FIFO, and WAC that are capable of affecting the company’s bottom line in various ways; therefore, it is essential to pick the right technique for the business.

Advantages and Disadvantages of FIFO

This strategy has four main benefits: (1) effective way of operation, (2) the unspecified flow cost typically match with the typical physical flow of items, (3) has no exploitation of profits, and (4) the balance sheet sum of supply that is likely to approximate the existing physical flow of items. These advantages happen since when a business sells products, the first cost it deletes from the list are considered the oldest element costs (Feng et al., 2014). A company cannot interfere with the income by picking the unit to ship since a serial number does not evaluate the price of a unit sold. Instead, the value assigned to the group sold is typically the oldest cost. On the other hand, some of its disadvantages engage the more significant tax burden it has when utilized for tax reasons in times of inflation. Still, it is not a useful assess if the products purchased have variable cost patterns as this can lead to misstated income.

Advantages and Disadvantages of LIFO

One of the benefits associated with the method includes its ability to provide a useful measure of the actual earnings by matching the most current cost against the new profits. When old prices are harmonized against existing taxes in an inflationary surrounding, the stock profit is initiated. Supply profit happens when the substitution cost of catalog is considered to be more than the stock cost harmonized against income. The strategy is also helpful as it reduces write-downs to marketplace since the net profits of any business that utilizes the LIFO strategy is less probably to be hindered by the reduction of price in the future. Typically, companies using this strategy do not have much supply at existing higher rates since the majority of new stock acquired at higher prices is sold first (Feng et al., 2014). Another advantage of LIFO is associated with the tax profits and enhancement in cash flows. When the technique is utilized in the times of inflation, the present purchases at bigger values are coordinated alongside the revenues that lessen the existing exaggeration of profit and thus decrease the income tax bill.

On the other hand, some of the disadvantages associated with this method engage low wages in inflationary times. This method lessens acquired earnings in times of price increase thus making several industries to have negative feelings that bookkeeping change to LIFO will pose a harmful effect on shareholders and might lower the prices of a business’s stock. There is also an irony of supply under this method as the balance sheet catalog figure usually is understated since it is centered on the previous values (Coelho & Laporte, 2014). There is also the issue of LIFO bankruptcy that may increase the reported returns for a particular time that will, in turn, engage in higher levy payments for the time. In avoiding this issue, the business may acquire products in big quantities to match them against earnings.

Advantages and Disadvantages of Weighted-Average

One of the benefits associated with the weighted average method engages the consistency in product cost utilized. After the accountant calculates the value of the goods, the price will also be used for other units, thus creating a consistent flow (Tom Jose, Akhilesh & Sijo, 2013). This incorporates the rate applied for the ending supply value together with the cost of supplies sold. The weighted average approach also engages less paperwork as it requires the accountant to carry out a direct calculation of one cost and utilize it for all other counts. The accountant maintains only fewer sheets of paper documenting the calculations. Still, as part of the advantages, the calculation used to evaluate the unit cost under this approach is more straightforward than that of other methods hence presenting a benefit to the business. The count only needs the accountant to finish three phases that make every part of the calculation more straightforward and effective.

Disadvantages associated with this technique is when the inventory process is different as the business may end up not recovering the expenses of the more costly units and may even suffer a significant loss with the sales price. The main idea behind this method is that the business will make up any loss when they sell less expensive materials (Tom Jose, Akhilesh & Sijo, 2013). The process also assumes that all units are the same, which is also a problem as newer commodities may have upgrades or extra features that may result in better prices than the previous stock units.

Recommendation

Having discussed the advantages and disadvantages of the three methods, coming up with the appropriate inventory valuation method for the Wild Water Sports Inc will rely on several factors including the location, whether the costs are going up or down, and how much the inventory differs. However, the company should benefit from the LIFO method to the weighted average due to the advantages it has more so the simple calculation part. This will bring fewer complications due to the fewer phases required in the calculation process. Regarding the financial implications, this switch is likely to affect the number of existing assets in the balance sheet and gross profit in the income statement.

 

References

Coelho, L. C., & Laporte, G. (2014). Optimal joint replenishment, delivery and inventory management policies for perishable products. Computers & Operations Research, 47, 42-52.

Feng, M., Li, C., McVay, S. E., & Skaife, H. (2014). Does ineffective internal control over financial reporting affect a firm’s operations? Evidence from firms’ inventory management. The Accounting Review, 90(2), 529-557.

Tom Jose, V., Akhilesh, J. K., & Sijo, M. T. (2013). Analysis of inventory control techniques; A comparative study. International Journal of Scientific and Research Publications, 3(3), 1.