Question

Golf Challenge Corp. is a retail sports store carrying golf apparel and equipment. The store is at the end of its second year of operation and is struggling. A major problem is that its cost of inventory has 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 primary financial statements for its second year. The numbers are not favorable. The only way the store can meet the required 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 at the bank for the required bank review. The owner thankfully reflects on the available latitude in choosing the inventory costing method.

How does Golf Challenge’s use of FIFO improve its net profit margin and current ratio?

Is the action by Golf Challenge’s owner ethical? Explain.

Answer 1

Answer)

Here,the price of sports units remain constant regardless the cost.Hence,when using LIFO we sell the high costs items first which result in low cost items to stay as closing stock(as it is mentioned in the question that cost of inventory continually increased in past two years) which results in decline net profits.When FIFO is used then profitspwill be high compared to LIFO.Similarly,the high cost inventory results high value of current assets which rises current ratio.

As per IRS,we can use two methods for valuation of inventory for financial statements and tax purposes.There won't be any change also as gold apparel and equipment have no expiry dates or so or increased value for old items.Hence,it will be ethical until golf challenge Corp. shows the least of cost or market value in books.