This paper seeks analyze and discuss the why different inventory methods are used for different industries. In so doing making the analysis, this paper asserts that different kinds of industries have different goods and services and even environments hat will influence the kind of inventory systems and inventory methods that they use. In addition, this paper also posits are the act of management of adopt an inventory method is basically governed by the principle of cost benefit analysis. Analysis and Discussion
The inventory methods include the FIFO and LIFO. , FIFO means first in first out, so that in period of rising prices, what remains in the inventory as cost pertain to those goods purchased at later and therefore higher prices. Higher cost of ending inventory means higher income and higher income means higher tax. Using FIFO therefore will bring higher taxes than using LIFO, which is the opposite of FIFO, where cost in inventory pertain for cost of earlier purchases and therefore at lower cost.
Since lower cost of inventory also means lower income, the company using the LIFO must be benefiting from tax benefits. Other kinds of inventory methods include the average method and the specific identification method. “Average inventory method just produces a cost flow based on a weighted average of unit costs and it produces results that are in between the LIFO and FIFO methods.
” Specific identification is the actually to be the most basic method as this could be used only when the company can actually identify the actual cost associated with a particular unit or product and is generally applicable when products are homogenous (Meigs and Meigs, 1995). The first three methods could actually be considered as using cost flow assumptions which need not follow the movement of the product. Certain industries have goods that are few in quantity but big items like the plane and ships manufacturers, or separate items but have high cost like fine jewelry companies.
while some industries have voluminous goods but small ones or of lesser values like the department stores. Inventory methods could be used between two types of inventory systems – the perpetual and the periodic. As to what distinguishes the two, perpetual system requires accounting records to show the amount of inventory on hand at all times, thus the need to maintain a separate account in the subsidiary ledger for each good in stock, which must be updated each time a quantity is added or taken out.
Under the periodic inventory system, the inventory is not updated as sales account gets recorded, thus necessitating the taking of physical count at the end of the year to determine the cost of goods sold (Petroff, 1991). This does not mean however that in perpetual inventory physical count should not be conducted, however, such is minimized or is as not as compelling as in periodic system because of the updated records under the perpetual system. Between the plane and ship manufacturer and the department store, the choice of inventory method is obvious.
The first manufacturer of big but few items or few but high value items would most likely use perpetual inventory system while the department store would use the periodic inventory system on the ground that under the perpetual inventory system a perpetual records will be kept and there is no need to conduct inventory at the end of the accounting period. The plane manufacturer would therefore consider absurd to conduct physical count to determine the cost of inventory.
On the other hand the department store would not be advised to use perpetual inventory system since it would be costly to keep a daily if not every minute movement of its inventory in the store. One could not imagine a store owner to record two small sardines in its ledger by hiring personnel to do the job. Hence, the most practical thing to do is just record purchases and makes a physical count of goods at the end of the accounting period to determine cost of goods sold (Helfert, E. , 1994).
Between the FIFO and the LIFO, the fine jewelry manufacturer would most like not use either but would rather go for Specific Identification as method since again there are only few products but high value and cost of tracking each product could be still justified (Financial-Education, n. d. ). It may even still choose to have perpetual but LIFO is there is tax benefit for adopting the same. Unlike the department store which will have daily sales which would necessitate the company to use LIFO over FIFO and less chance of specific identification since it would be more costly to track each item in the inventory
In the case of American companies, a number of large and small companies use the LIFO because US laws allows them to use LIFO for tax purpose. However in case of American multi-national companies (MNCs), their adoption on LIFO may not be allowed by the government of their foreign subsidiary hence some may used mixed inventory methods (Chung, n. d. ) In addition, it was also found that all American shifts from FIFO to LIFO for tax purposes benefits as shifting could involve switching cost that may affect the balance of cost benefit consideration.
Conclusion This paper was able to prove that different industries have different goods and even environments that will influence the kind of inventory systems and inventory methods that they use and that the management’s adoption of an inventory method is basically governed by the principle of cost benefit analysis for the company. In this paper, the jewelry manufacturer would be more likely to use perpetual inventory system and inventory methods of either specific identification or LIFO over that FIFO if the company is allowed to have tax benefit.
In the case of industries having voluminous and heterogeneous products, like a department store, the adoption of periodic inventory system and LIFO or FIFO would be more likely to be used because of the cost flow assumptions and difficulty of using specific identification. In the case of American purely domestic companies, the use of LIFO may be allowed for tax purposes but for American MNCs, they can used methods allowed inventory by the government of their foreign subsidiaries.
Moreover, not all companies adopt LIFO because there are switching costs when they have already use other methods in the past, which will affect the balance of benefits and costs even with promise of tax benefits.
References:
Chung, Shifei, (n. d. ) An Empirical Analysis of the Inventory Accounting Methods on. U. S. Multinational Companies: Segment Effects {www document} URL, http://blake. montclair. edu/~cibconf/conference/DATA/Theme8/Usa. pdf, Accessed August 15, 2007 Financial-Education (n. d ), Inventory Accounting Methods: LIFO, FIFO, Weighted Average and Specific Identification, http://financial-education. com/2007/03/05/inventory-accounting-methods-lifo-fifo-weighted-average-and-specific-identification/ Meigs and Meigs (1995) Financial Accounting, McGraw-Hill, London, US Petroff, John (1991) Chapter 10: INVENTORY, {www document} URL, http://www. peoi. org/Courses/ac/ac10. html, Accessed August 15, 2007 Helfert, E. (1994), Techniques for Financial Analysis, IRWIN, Syndey, Australia