Question

Beyond the Numbers A10 BTN 5.1 Golf Challenge Corp. is a retail sports store carrying golf apparel and equipment. The store is at ETHICS the end of its second year of operation and is struggling. A major problem is that its cost of inventory has CHALLENGE continually increased in the past two years. In the first year of operations, the store assigned inventory costs using LIFO. A loan agreement the store has with its bank, its prime source of financing, requires the store to maintain a certain profit margin and current ratio. The store's owner is currently looking over Golf Challenge's preliminary financial statements for its second year. The numbers are not way the store can meet the financial ratios agreed on with the bank is to change from LIFO to FIFO. The store originally decided on LIFO because of its tax advantages. The owner recalculates ending inventory using FIFO and submits those numbers and statements to the loan officer for the required bank review. The owner thankfully reflects on the available latitude in choosing the inventory costing method.

1. is Golf Challenge's change from LIFO TO FIFO ethics ? Consider whether such a change would be misleading to investors.

2. under what type of circumstance should a company be permitted to change inventory costing methods?

Answer 1

(1): No, the Golf Challenge Corp. has not been completely ethical here. There are certain rules that have to be followed and adhered to when changing from LIFO to FIFO. For instance there are discourse requirements that need to be followed and a full disclosure principle has to be adopted. Golf Challenge Corp’s financial statements would need to inform prospective investors that there was a shift from LIFO to FIFO as well as detail what the effect of that shift could be. Switching to the FIFO method is good decision for the company but only ethical if the owner follows the rules of switching. Here the owners of Golf Challenge Corp. should have informed the bank about the switch and also, the shareholders if applicable, and the change needs to be noted on all financial statements and tax forms.

Such a change will be misleading to investors if they are not properly informed about the change.

(2): A company will be permitted to change its inventory costing methods under the situation in which the company has completed one full year of business operations and in a situation in which the company finds that the business situation and conditions have changed so as to make it necessary for the company to change its inventory costing method. The company seeking to change its inventory costing method will have to ensure that the transition is being done correctly.