Question

When answering the provided questions, you must ensure that your answers address the questions, that your answers have an Australian accounting/financial reporting focus, that your answers are internally consistent, and that the individual components of your answers provide a well-rounded argument that is easy to follow.

The Chief Financial Officer (CFO) of Large Mart has been unable to find answers for two accounting problems. He has asked you to investigate the following questions and to write a report (including relevant references to source materials and accounting standards) that will provide him with a sufficient understanding of these issues to allow a well-supported decision to be made. To achieve this, the CFO seeks you to answer specific questions, but also to outline the development of your answers sufficiently to allow a reader to understand why you have developed your answers.

Question:

The Chief Executive Officer (CEO) of Large Mart has asked the CFO if it is possible to change the cost flow assumption that is used to value Large Mart’s inventory. At the moment, Large Mart is using the First-In-First-Out (FIFO) cost flow assumption (in a perpetual inventory accounting system) and although the CEO would like to retain a perpetual inventory accounting system, she would prefer the application of a different cost flow assumption. The CEO would like to make this change because she believes that this could potentially improve Large Mart’s financial position in the balance sheet.

The CFO asks you to investigate, and write a report about, the following questions:

a)     What are the legal requirements in relation to changes in inventory cost flow assumptions for reporting entities in Australia? In your answer, you should discuss (1) whether or not changes to cost flow assumptions are permissible in principle and why, and (2) what valuation options (other than FIFO) may be available to Large Mart. (500 Words)

b)     What are the legal limitations to changes in cost flow assumptions for reporting entities in Australia? In your answer, you should discuss (1) what legal restrictions would limit Large Mart’s ability to make changes to their inventory cost flow assumptions, and (2) whether or not the reason why the CEO would like to make this change may have any impact on Large Mart’s ability to make such a change. (500 Words)

Answer 1

1. 1) Changes to cost flow assumptions are permissible if it is required for compliance of law, reporting framework & if it results in better (True & fair) presentation of financial statements. The Internal Revenue Code specifies that in order for a firm to use LIFO for tax filing, it must also use LIFO for financial reporting. During price rising, LIFO results in the lowest taxable income and tax liability because it yields the highest cost of goods sold as a result of assigning the more recent higher purchase cost to goods sold, and the older/lower cost to ending inventories. To reduce taxes and retain more cash for other more productive purposes, the majority of U.S. firms choose LIFO for tax filing, thereby complying with the LIFO conformity rule by also using LIFO for financial reporting.