Memorandum Case

Memorandum

To: Ms. Gonzales

From: your name

Date: December 6, 2012

Re: Inventory Valuation

The recommendations I would give to you for your concern on your business in periods of rising prices would be the LIFO inventory valuation. Between the two methods FIFO in which you have used before and LIFO I will be able the difference in the two methods and explain on why the LIFO method for rising prices would be a better approach for you business.

The first inventory valuation is FIFO. This method is defined in (Wild, Shaw, and Chiappetta, 2010,P233) as the first in, first out assigned cost to inventory that assumes items are sold in order acquired; earliest items purchased are the first sold. Business managers usually prefer FIFO when cost are rising and incentives exist to report higher income for reasons such as bonus plans, jobs security, and reputation (Wild, Shaw, and Chiappetta, 2010, p. 236). In this case since the prices are rising FIFO gives a better indication of the value of ending inventory, but also increases net income due to inventory being old is used to value the cost of goods sold (Investopedia, 2006). Companies that sell perishable goods such as food and drugs tend to lean towards this method because the cash flow resembles goods flow. Since this method increases net income, which is good, it can also increase the amount of taxes that the business would own.

The second inventory valuation is LIFO. This other method is defined in (Wild, Shaw, and Chiappette, 2010, P233) as last in, first out a method to assign cost to inventory that assumes costs for the most recent items purchased are sold first and charged to cost of goods sold. This method is also preferred by businesses when it comes to matching of the most recent (higher) cost against revenue through cost of goods sold. LIFO as the inventory method is not a good indicator of the ending inventory value due to the leftover of inventory (Investopedia, 2006). This gives you the result in higher cost of goods sold which in turn would lead a lower net income and lower tax. A major benefit from LIFO is that using this method the companies always use the newest items first, in which the cost of goods will always be at its greatest amount and therefore the net income before taxes will be at its lowest amount and the taxes will be minimized. The LIFO method is justified based on the matching principle, as the recent inventory is matched against the current revenue generates sale from that inventory.

In conclusion to the two inventory method and to the business situation that is at hand this problem tends to lead to the LIFO method the most because of the advantage of the income tax to be at its lowest. FIFO is a great method for indication to the value of ending