Question

Prepare a written memo addressing the factors that should be considered by Gilbert Industries in choosing between LIFO and FIFO. Your memo should show a level of comprehension of both methods and explain why you advise one methodology over the other.

Written Communication AP6–7 You have just been hired as a consultant to Gilbert Industries, a newly formed company. The company president, Mindy Grayson, is seeking your advice as to the appropriate inventory method Gilbert should use to value its inventory and cost of goods sold. Ms. Grayson has narrowed the choice to LIFO and FIFO. She has heard that LIFO might be better for tax purposes, but FIFO has certain advantages for financial reporting to investors and creditors. You have been told that the company will be profitable in its first year and for the foreseeable future. Required: Prepare a report for the president describing the factors that should be considered by Gilbert in choosing between LIFO and FIFO.

Answer 1

Hey buddy !!

The following is a detailed note on FIFO & LIFO. The analysis helps you in the choice for the same.

Under FIFO the assumption is that the oldest inventory is used first. (In many businesses that is in fact what happens, regardless of the accounting method.) As a result, the ending inventory is valued on your balance sheet at a cost closest to the current cost since prices tend increase over time. The cost of goods sold is based on a lower cost since older and therefore cheaper items are assumed to be the items sold. Under LIFO the assumption is that the last items purchased are the items sold, meaning the more expensive items were used. The cost of goods sold is therefore relatively higher and the value of goods remaining on the balance sheet is lower since those are older items purchased at a lower price. (Again, assuming that prices have increased over time.) Under LIFO your profits are lower compared to FIFO accounting. So where does business strategy come into play? If you feel your inventory costs are likely to remain stable or increase, the LIFO approach probably makes sense. Companies that use LIFO inventory valuations are typically those with relatively large inventories and increasing costs because LIFO typically results in lower profit levels, lower taxes, and as a result higher cash flow.Think of LIFO accounting as providing a deferred tax advantage. LIFO also results in a weaker balance sheet since the value of your inventory is lower. FIFO inventory accounting provides more accurate inventory valuations since the assumption is the items remaining in inventory were purchased at more recent--and typically higher--prices. Under FIFO the value of inventory is higher compared to LIFO.

Conclusion:

If you sell products as a retailer or a manufacturer and the cost of your supplies or products tends to increase over time using LIFO will typically result in lower taxable income which results in lower taxes compared to the FIFO.But keep in mind that if you need to maintain a relatively strong balance sheet--to qualify for loans, to satisfy investors, or to impress analysts--FIFO is the best option. So as per a general purview rather than lowering the taxes it is important that the advantageous position to investors and creditors. Thus as a consultant I would advise Gilbert Industries to go with FIFO Method as it would be beneficial both in short term and long term.

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