You recently graduated magna cum laude from Hampton Universitys School of Business. You are currently working hard at your first job and hope to move up in the firm. Periodically, you meet with some of your former classmates over lunch and discuss how your and their businesses and careers are doing. During one of these discussions, one of your former classmates mentions that the firm she is working for is doing poorly and may not show a profit for the current year. To make the financial statements look better, she recommended to the President of the firm that they switch their inventory costing method from LIFO to FIFO. By doing this, Cost of Goods Sold will decrease enough for the firm to show a small profit in the current year. This is more important than the slightly lower ending merchandise inventory. She also mentions that because the firm will be profitable after the switch, they will have to pay more income taxes than if they did not make the change. Despite the inventory valuation method used, they will have the same physical items in ending inventory. Your friend also explains that since the firm enjoys the tax advantages of LIFO, they can switch back next year when the business is more profitable. Since the firm that you work for is also experiencing temporary economic difficulties and expects next year to be much more profitable, she recommends that you make the same recommendation to the management of your firm and get the pat on the back and possible raise that may result from your excellent advise.
Leaving the lunch, you wonder whether you can score brownie points with your boss by making the same recommendation. Thinking back to your days in Principles of Accounting, you remember that there are other issues and problems with switching to and from acceptable accounting principles. You wonder whether the companys auditor will sanction the switch to FIFO for one year and the switch back to LIFO after one year. Also, being a Hampton University graduate, you wonder whether it is morally correct to switch accounting principles solely to manipulate income.
Write a memo to your friend addressing your concerns. Specifically address the following:
Does switching from one acceptable accounting principle to another acceptable accounting principle violate any accounting concept such as the Consistency Principle? Explain how the principle is violated.
How is the switch reported on the financial statements (remember the Full Disclosure Principle)? Does making the switch serve the needs of the users of the financial statements? Explain.
As a Hampton University Graduate steeped in the moral code of the University, are you going to make the recommendation to your boss?