4) At the first joint meeting of the FASB, IASB and EASB (Endorian Accounting St

Question

4) At the first joint meeting of the FASB, IASB and EASB (Endorian Accounting Standards Board) the controversy over inventory arose. The EASB allows LIFO and NIFO (next in first out) which values inventory at the price of acquiring the next unit. Their argument is that this is the minimum price at which the merchandise would be sold, and obsolete inventory would have no value. FASB allows LIFO but not NIFO and of course IASB does not allow either one. The US-IRS has stated that they will NOT change their policy regarding the requirement of LIFO for books if it is used for taxes, thus any removal of LIFO from GAAP would cause an increase in taxes for US Companies. For some unknown reason (maybe they listened to too much of Mr. Spock’s singing) they have come to you for advice. Should NIFO be allowed for financial accounting purposes why or why not? Should LIFO be allowed for financial accounting purposes why or why not? DEFEND your answer including the impact these methods have on income statements, taxes and balance sheets.

Explanation / Answer

NIFO -

NIFO is a method of valuation where the cost of a particular item is based upon the cost to replace the item rather than on its original cost.However, NIFO is not acceptable for financial reporting since it calls for a future cost. NIFO is sometimes used as an expression of replacement cost.This method is not considered a generally accepted accounting principle (GAAP).

Therefore NIFO Method should not be allowed for financial accounting purposes because it is said to violate the cost principle.

LIFO -

This method assumes that inventory purchased last is sold first. Therefore, inventory cost under LIFO method will be the cost of earliest purchases.

The major reason of using LIFO method of inventory valuation is its tax benefit. When LIFO is used during inflation, the current purchases at higher prices are matched against revenues that alleviate the overstatement of profit and therefore reduce income tax.

The value of your balance sheet inventory increases as you lower your COGS by liquidating LIFO inventory. The side effect is a higher level of working capital and current assets. You might want to disclose the effect of LIFO liquidation on your COGS in your financial reporting.

If LIFO method is used in a rising-price and increasing-inventory environment, more of the higher-cost goods (last ones in) will be accounted for in COGS as opposed to FIFO. Under this scenario, net income will be lower compared to a company that used FIFO accounting.

So, after understanding both the methods LIFO Method should be allowed for financial accounting purposes.

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