Question

You are a financial advisor with a client in the wholesale produce business that just completed its first year of operations. Due to weather conditions, the cost of acquiring produce to resell has escalated during the ladder part of this period. Your client Gish mentions that because her business sells perishable goods, she has striven to maintain a FIFO flow of the physical goods. Although sales are good, the increased cost of inventory has put the business in a tight cash position. Gish has expressed concern regarding the ability of the business to meet income tax obligations.
Required:
Prepare a memorandum that identifies, explains, and justifies the inventory method you recommend your client, Ms. Gish, adopt.

Answer 1

Answer:

Answer is explained below.

Explanation:

Better inventory costing system:

The  wholesaler  is  using  FIFO  method  of  inventory  valuation and getting the following

advantages.

1. The net profit calculated using FIFO is higher than LIFO method. So, the net profit margin will  increase

2. The closing inventory value is higher in case of FIFO inventory costing. So, the current assets  will increase thereby increasing the current ratio also.

However, the wholesaler has some financial constraint, so it is better to adopt LIFO method of  inventory valuation because of the following advantage.

3. The net profit calculated under LIFO method is lower as the cost are goods sold are higher. The  lower net profit gives the tax advantage. So, she should adopt LIFO method to save tax.