Due Day 3: An Executive In A Merchandising Company Receives

Due Day 3an Executive In A Merchandising Company Receives An Annual Bo

Due Day 3an executive in a merchandising company receives an annual bonus equal to 5% of net income. Historically, the company has calculated cost of goods sold and ending inventory using LIFO and has maintained 30,000 units in inventory for the last ten years. The executive is recommending the company reduce the number of units in year-end inventory to 1,000. Over the ten-year period, the cost per unit of inventory has increased from $60 per unit to $110 per unit. Respond to the following in a minimum of 175 words: In what ways would a reduction in inventory help the company? In what ways would the change from LIFO to FIFO help the executive personally? Would you approve the proposal to move from LIFO to FIFO? Why, or why not?

The proposed reduction in inventory levels from 30,000 units to only 1,000 units could significantly impact the company's financial and operational efficiency. By substantially decreasing inventory, the company might reduce holding costs, including storage, insurance, and obsolescence risks, which could improve profitability margins in the short term. Additionally, a lower inventory level might enhance cash flow, freeing cash for other investments or debt repayment. However, such a drastic reduction could also pose risks, such as stock shortages, inability to meet customer demand promptly, and potential disruptions in the supply chain. Moreover, it could signal supply chain issues or poor inventory management, potentially damaging the company's reputation and operational stability.

Switching from the Last-In, First-Out (LIFO) inventory accounting method to First-In, First-Out (FIFO) could benefit the executive personally primarily through its impact on financial reporting. FIFO typically results in higher reported net income during periods of rising prices because older, cheaper inventory costs are matched against current sales. Consequently, this shift could lead to increased bonuses tied to net income, aligning the executive's personal financial interests with the change. Additionally, FIFO may improve the company's balance sheet by reflecting higher inventory values, which might enhance borrowings or investor confidence.

However, whether to approve the transition from LIFO to FIFO involves weighing ethical considerations and the company's strategic goals. While FIFO can provide a more favorable view of earnings and asset values, it may distort comparability with past financial statements and could be seen as an attempt to manipulate earnings for personal gain. Given the increasing costs per unit over time, switching to FIFO might overstate profits and inflate the company's valuation temporarily. My inclination would be to scrutinize the motivation behind the change and assess its alignment with transparent accounting practices. If the change is justified by legitimate operational benefits and not solely for personal gain, it could be considered appropriate. Otherwise, maintaining consistent accounting methods in accordance with Generally Accepted Accounting Principles (GAAP) would be prudent to preserve financial statement integrity and stakeholder trust.

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