Silver Corporation (SC) – an oil refining company is dealing in oil refining and marketing business for the last two years. The company has centralized decision making system, so all the decisions are made by the top level management at its head office located at Oil City. Due to poor economic conditions in the country, the prices of inputs have risen to an abnormal hike. Due to this inflationary pressure, the companies are facing with the higher cost of production and this has ruined the corporate profits. To tackle this alarming situation, SC has appointed a certified cost analyst to figure out the main cost issue.
After detailed observation, the analyst concluded that the company needs to improve its inventory costing system. He argued that, if the company successfully manages the inventory then the cost will be reduced remarkably.
On the basis of the analyst’s recommendations, the management assigned a task of improving its inventory costing system to Mr. White – Operations Manager, and Mr. Blue – Store Manager. They designed an initial inspection plan to analyze the inventorymovements during different frame of periods. Their intention was to search and recommend at least the most efficient inventory costing system. After completing the analysis, both the managers came up two different recommendations – Mr. White recommended the use of FIFO costing method as this will lower the company’s taxable income. Whereas, Mr. Blue came up with the suggestion to adopt LIFO costing method as this may help the company in acquiring loan from any bank.
The management feels it difficult to decide which one of these two to adopt, as both are conducive.
As a student of cost accounting you are asked to help the SC management that either the recommendations given by both managers (Mr. White & Mr. Blue) are appropriates for inflationary period (Ignore IAS – 2 on Inventory) or not? Support your answer with logical reasoning.
Mr. blue is wright because under LIFO method cost of goods sold will be highest thus lower tax margins which will increase the cash in flow. and then the company can borrow more money of basis of more cash inflow.
and MR. white is saying FIFO will lower the taxable income, but FIFO increases the taxable income as it increases the net income, so more income = more taxes ..
as FIFO is concerned, but we have to answer if Mr White and Mr Blue is right or wrong. In my opinion both are wrong. In context of FIFO you have already mentioned the correct answer and in case of LIFO answer , our aim/ mandate is not to get loan from bank but to suggest appropriate answer for the company. By getting loan we are increasing the problem of company and especially in context of inflation. The old inventory will get more effect of inflation. So my conclusion is that both have given wrong answers to company.