question archive Paragliding Corp
Paragliding Corp
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Paragliding Corp. is a mercha
Golf Mart is a retail sports store carrying golf apparel and equipment. The store is at the end of its second year of operation and is struggling. A major problem is that its cost of inventory has continually increased in the past two years. In the first year of operations, the store assigned inventory costs using LIFO. A loan agreement the store has with its bank, its prime source of financing, requires the store to maintain a certain profit margin and current ratio. The store’s owner is currently looking over Golf Mart’s preliminary financial statements for its second year. The numbers are not favorable. The only way the store can meet the required financial ratios agreed on with the bank is to change from LIFO to FIFO. The store originally decided on LIFO because of its tax advantages. The owner recalculates ending inventory using FIFO and submits those numbers and statements to the loan officer at the bank for the required bank review. The owner thankfully reflects on the available latitude in choosing the inventory costing method.
Required
How does Golf Mart’s use of FIFO improve its net profit margin and current ratio?
Is the action by Golf Mart’s owner ethical? Explain.
ndizer carrying para gliding gear and kit. At the end of its third year of
operation and is struggling. A major problem is that its cost of inventory has continually increased in
these three years. In the first year of operations, the store assigned inventory costs using LIFO. A loan
agreement the store has with its bank, its prime source of financing, requires the store to maintain a
certain profit margin and current ratio. The store's owner is currently looking over Paragliding's
preliminary financial statements for its third year. The numbers are not favorable.
Required:
As an Advisor you must recommend a method that how does Paragliding Corp. improve its net profit
margin and current ratio using Inventory costing methods? And defend your Answer that how it improves
store's net profit margin and current ratio. Also explain that is your answer comply with laws and ethics?
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Answer:
The FIFO and LIFO valuation methods and both methods value inventory very differently. Switching from FIFO to LIFO can have a significant impact on all financial statements. A business switching from FIFO to LIFO will have to restate its financial data for prior years to reflect the new method. Also business will always have to disclose the change in the footnotes to the financial statements.
FIFO vs. LIFO
FIFO stands for first-in, first-out. In FIFO inventory received first are sold / issued first. LIFO stands for last-in first-out, here latest inventory items are the first sold / issued.
As GolfMart used FIFO where the closing stock of GolfMart is now valued by the latest purchase. Further, because of inflation latest purchases of GolfMart will be at the increased price then the previous purchase. Hence the value of Closing stock would be more in FIFO then LIFO.
As both profit margin and current ration considers closing stocks also, the FIFO methos has improved the net profit margin and current ratio of Golfmart.
Yes, the action of GolfMart is ethical. This means that GolfMart can do this as per GAAP. But it has to all condition related to change in Inventory valuation method.
Disclosure Requirements
Financial statements are required to disclose all significant changes in accounting policies. This is done to comply with accounting’s full-disclosure principle. Also, to make the conversion possible, U.S. GAAP requires companies that use LIFO to report a LIFO reserve. The LIFO reserve is the difference between what their ending inventory would have been if they used FIFO.
