Characteristics of Accounting Information
Characteristics of Accounting Information
The inventory system of any business affects the profitability of the business. Therefore, it is very important to adopt the most suitable inventory system to increase the profitability and the reliability of the financial statements. The change in inventory valuation method from FIFO method to Average method can change the figures of closing inventory in the balance sheet and reduce or increase the cost of sales in the income statements. The inventory valuation technique which suits best to reduce the tax expense can be adopted. However, it is important to understand that the change in valuation method does not provide the most reliable information for the management in the planning of the inventory because of the fluctuation in the purchase prices. (Sponaugle)
The main advantage of switching the valuation method to FIFO valuation method is that if the stock prices are increasing then the FIFO method will help the management to consume the inventory which was purchased before other stock in the warehouse. This technique will increase the profits of the business by keeping the selling price higher and purchase price at the lowest. However, the main disadvantage of using FIFO method is that due to higher profits, the amount of tax expense also increases. (Sponaugle)
The advantage of the Average method for stock valuation, using instead of FIFO and LIFO is that, it provides the best results when the purchase price of the inventory is facing high fluctuation. It gives the highest value for all the inventories of the similar characteristics. The main disadvantage is that average method is difficult to use and it can create errors in the calculation of the average amount. Moreover, if the management of the business plan the budgets according the average purchase price of the inventory, then it is highly probable that the management will prepare the wrong budgets. (Johnston)
References
Sponaugle, B. (2014, May 1). FIFO vs LIFO: The Disadvantages and Advantages to Inventory
Valuation. Retrieved January 19, 2016, from https://blog.udemy.com/fifo-vs-lifo/
Johnston, K. Advantages & Disadvantages of Average Cost Method. Retrieved January 19,
2016, from http://smallbusiness.chron.com/advantages-disadvantages-average-cost-method-63677.html
