- For Randy Hetrick of Fitness Anywhere, the major challenge was maintaining appropriate levels of inventories while controlling costs. What is meant by this statement?
Randy Hetrick of Fitness Anywhere is in the business of providing specialized exercise equipment. He is the inventor of an exercise device the TRX suspension trainer. He therefore is in the business of production of this device as well. Randy had to come across several issues related to inventory as he couldn’t hold big quantities of his product as the demand for the device was not been established in the market and at the same time producing in smaller quantities was relatively expensive. So controlling the costs while maintaining substantial levels of inventory became challenging for Randy. In the beginning as a new comer in the industry he had to face issues like fulfilling the orders, money collection and managing discounts, returns allowances. These things though added to the challenge yet gave Randy experience as how to manage his inventory. Monitoring the inventory as well as costs incurred helped Randy out while facing the challenge of inventory management.
- Explain the effects of inventory valuation methods on the cost of ending inventory, income, and income taxes.
There are four methods used to value the inventory i.e. LIFO, FIFO, Average Cost and Specific Identification method. Not all of the affect the cost of ending inventory, income and income taxes, yet some have good while others have adverse affects on the said financial indicators.
In case of the cost of ending inventory; the average cost method results in higher average unit cost of ending inventory, whereas specific identification method has no impact on the cost of ending inventory. However, LIFO has adverse affects on it, as under this method last unit purchased is sold out first due to which the remaining inventory could possibly be extremely old & may understate the inventory at current prices. In case of FIFO, the figures of the ending inventory may reveal some good news yet there is a chance of overstating the inventory at current prices.
Analyzing the affects of inventory valuation methods on Net Income; Under FIFO since the first units purchased are sold out first, the net income amounts are higher, in a deflationary environment however, FIFO method of inventory valuation may generate relatively lower Net Income. On the contrary, in case of LIFO method, the net income amounts are relatively lower, but in the economic situation where prices are falling, LIFO method of inventory valuation may generate comparatively higher Net Income. The companies using average cost method have higher net income figures in a falling price environment and the opposite in case of escalating price environment. The specific Identification method does not impact the Net Income directly, as it depends on the changes in the inventory acquisition costs.
The affect of inventory valuation methods on Income Tax; firms tend to opt the LIFO method for tax benefits during inflation, when switching to LIFO the net income may drop and the firm can get tax benefit with lower figures. Whereas in case of FIFO the reverse will apply as lower inventory will naturally increase the gross profit and vice versa. Average cost method and specific identification methods do not impact the Income Tax directly. The firms may opt to switch to other methods from these in order to gain certain tax benefits.
References
James Clausen. (2010). Income Tax Liability and LIFO Inventory Valuation Method. Retrieved from. http://suite101.com/article/income-tax-liability-and-lifo-inventory-valuation-method-a224342
Reporting and Analyzing Inventories. (n.d) Retrieved from. http://highered.mcgraw-hill.com/sites/dl/free/0078025389/938607/wild6e_sample_ch05.pdf
