Week 3 DQ + Journal

DQ 1. The controller of Sagehen Enterprises believes that the company should switch from the LIFO method to the FIFO method.  The controllers bonus is based on the next income.  It is the controllers 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?

Answer:

LIFO means Last in First Out that the product purchased first should be sold first. When a company does it that means its Cost of Goods Sold is shown at the most recent price and closing inventory is shown as more past price. That is way gross profit so do net profit is understated under LIFO method and closing inventory is overstated. In these situation managers (controllers) expecting commissions on net profit want to adopt FIFO method thinking that its profit will be increased in a ways of showing lower cost of goods sold. In that case closing inventory is shown in more increased amount. This the main difference between two.

DQ 2. A variety of depreciation methods are used to allocate the cost of an asset to all of the accounting periods benefited by the use of the asset.  Your client has just purchased a piece of equipment for $100,000.   Explain the concept of depreciation.  Which of the following depreciation methods would you recommend: straight-line depreciation, double declining balance method, or an alternative method?

Answer:

Depreciation is the process of distributing the cost of particulars asset to it useful life in where the asset provides the future benefits. In the process of distributing cost of assets to useful life so that it’s complied with matching principle of conceptual framework. But there is no straight forward answer that which depreciation method is more appropriate or recommended. It mainly depends on the uses pattern of the assets. Like if asset provides equal benefits to all concerned useful life, straight line method is more appropriate. Similarly if an asset provides more benefits in the earlier life than in letter life that double declining balance method is more appropriate. If assets uses depends on working unit or production unit then sum of the year digits method is appropriate.

Inventory Journal
Reflect for a moment on the LIFO (Last in First Out) and FIFO (First in First Out) inventory methods. If you were starting a small manufacturing company, what inventory method do you believe would provide the most accurate financial statements? Why do you believe this is the case?

Answer:

If I was starting a small manufacturing company I think FIFO inventory system would provide most accurate result because it makes sense. As we know manufacturing goods are subject to expire date and it is sometimes perishable. So first produced should be sold first in this case, otherwise business will face loss due to perishable nature of goods or if LIFO is used most manufactured goods will be beyond its expiry date. So in that case FIFO method will sense more than LIFO. Moreover income statements will be more representative if FIFO is used as well as Cost of Goods Sold for manufacturing company. International Accounting Standard (IAS-2) also recognizes this fact. They banded the LIFO method in 2003.

I believe so because if you are a manufacturing concern you have to purchase your raw material. This raw material will be used in the production process. These raw materials are often perishable in nature. Now suppose you use newer purchased raw material to your production process and let your earlier purchased raw material in the store. You did it because you have to consistent with LIFO method. It will get your earlier purchased raw material rotten that means you can not avail it’s in your production process. That’s way you will be in a loss. So in these case if you follow FIFO inventory systems and in order to make it consistent use earlier purchased raw material in the production process with proper care you will be able to maximize the use of your raw material and make your business profitable.

It is seen that not only in the manufacturing concern but also in the other business like merchandising, servicing earlier purchased goods should be used earlier and that is consistent with the FIFO method. So the use of LIFO method most of the time does not make sense but FIFO does. That’s way manufacturing business should follow FIFO in their inventory management systems.