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Accounting use the internet to research the annual report of at least one (1) merchandising company. Determine which costing method (Last In First Out [LIFO], First In First Out [FIFO], or weighted average cost) that is used to record inventory by your selected company. Identify the three (3) primary advantages and three (3) primary disadvantages of using the costing method (LIFO, FIFO, and weighted average) that is used to record inventory. Provide support for your response.

Paper For Above instruction

The objective of this paper is to analyze the inventory costing method employed by a merchandising company based on its annual report and to discuss the associated advantages and disadvantages of that particular method. Inventory management and valuation are pivotal aspects of a company’s financial reporting, significantly impacting its gross profit, net income, and tax liabilities. Among the most widely used inventory valuation methods are Last In First Out (LIFO), First In First Out (FIFO), and weighted average cost. Each of these methods has distinct implications for financial statements and strategic decision-making.

Selection of a Merchandising Company and Inventory Method Identification

For this analysis, I selected Walmart Inc., a prominent global retail corporation, and examined its annual report accessible through its investor relations webpage. Walmart’s inventory valuation method, as disclosed in its accounting policies, is the First In First Out (FIFO) method. FIFO assumes that the oldest inventory items are sold first, and the remaining inventory comprises the most recently acquired goods. This method aligns with the typical flow of perishable goods and often reflects current market prices in its ending inventory valuation.

Advantages of FIFO

1. Reflects Current Market Conditions: FIFO yields ending inventory values that are close to current replacement costs, offering a realistic approximation of the inventory’s current worth. This aspect is significant during periods of inflation, where FIFO results in higher ending inventory values on the balance sheet (Weygandt, Kieso, & Kimmel, 2020).

2. Simplifies Record-Keeping: FIFO is relatively straightforward to implement; it aligns with the natural flow of inventory such as perishable goods, making it easier for companies to track inventory layers.

3. Enhances Profitability During Inflation: In inflationary environments, FIFO tends to produce higher net income, since the cost of goods sold (COGS) reflects older, lower purchase prices, thus increasing reported profit (Brigham & Houston, 2019).

Disadvantages of FIFO

1. Tax Implications: Higher reported profits due to lower COGS may lead to increased tax liabilities. Firms might pay more taxes during inflationary times, reducing cash flow.

2. Potential for Earnings Management: The higher net income might be manipulated or seen as less conservative, which could artificially inflate financial performance.

3. Not Reflective of Actual Physical Flow in Some Industries: FIFO may not correspond with the actual physical flow of goods, especially in industries where items are consumed or sold in a particular order, such as manufacturing or storage of non-perishable goods.

Advantages of LIFO (Contrasting for Context)

While Walmart employs FIFO, understanding LIFO’s advantages highlights differences. LIFO assumes that the most recent inventory items are sold first, which can result in lower taxable income during inflationary periods due to higher COGS (Penman, 2012). However, LIFO can lead to inventory valuation distortions and is prohibited under IFRS.

Advantages of Weighted Average Cost

This method smooths out price fluctuations by averaging purchase costs, providing stable COGS and inventory values. It simplifies inventory evaluation when inventory items are indistinguishable (Garrison, Noreen, & Brewer, 2018).

Disadvantages of Weighted Average Cost

It may obscure cost flow assumptions, and during rapid price changes, it can distort profit margins and inventory valuation, leading to less precise financial analysis.

Implication for Financial Reporting and Decision-Making

Choosing FIFO aligns with Walmart's inventory management and reflects current market conditions, providing clarity for investors and stakeholders. However, corporations must balance transparency with tax considerations and the relevance of financial data under different economic conditions.

Conclusion

The selection of an inventory valuation method bears significant financial and strategic implications. Walmart’s use of FIFO is consistent with its operational structure, providing benefits such as simplified record-keeping and more current inventory valuation, especially advantageous during inflation. Nonetheless, companies must weigh these benefits against disadvantages like potential tax burdens and misalignment with physical inventory flow. An informed choice of method enhances financial reporting accuracy and aids in sound managerial decision-making.

References

Brigham, E. F., & Houston, J. F. (2019). Fundamentals of Financial Management (15th ed.). Cengage Learning.

Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial Accounting (16th ed.). McGraw-Hill Education.

Pennman, R. H. (2012). Financial Statements Analysis and Security Valuation. McGraw-Hill.

Weygandt, J. J., Kieso, D. E., & Kimmel, P. D. (2020). Intermediate Accounting (17th ed.). John Wiley & Sons.

Walmart Inc. (2022). Annual Report 2022. Retrieved from https://www.walmart.com/annualreport

International Financial Reporting Standards (IFRS). (2019). IAS 2 Inventories. Retrieved from https://www.ifrs.org/

Arnold, G. (2019). Corporate Financial Reporting and Analysis (8th ed.). Routledge.

Healy, P. M., & Palepu, K. G. (2012). Business Analysis & Valuation: Using Financial Statements (5th ed.). Cengage Learning.

Chen, S., & Wang, J. (2017). Impact of Inventory Valuation Methods on Financial Ratios. Journal of Accounting Research, 55(2), 341-382.

Financial Accounting Standards Board (FASB). (2020). Accounting Standards Codification (ASC) 330-10: Inventory. Retrieved from https://asc.fasb.org/