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 [By Staff Reporters]

The new administrator for the ABC Medical Clinic understood that all inventory costing methods were acceptable to use in his Durable Medical Equipment [DME] department. LIFO, FIFO, specific identification, and the average cost method are all attractive methods under different circumstances in the business cycle, and companies may use the method that best fits their circumstances.

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Reducing Taxes

For example, if ABC wished to reduce corporate income taxes in a period of inflation and rising prices, it would use LIFO. If matching DME sales revenue with the current cost of DME goods sold was desired, LIFO would also be used. Unfortunately, LIFO may charge against DME revenue the cost of DME not actually sold, and LIFO may allow the ABC Medical Clinic to manipulate net income by varying the time-periods it makes additional DME purchases. On the other hand, FIFO and specific identification method allows a more precise matching of ABC revenue with historic DME costs. However, FIFO too, can promote “paperless-phantom profits,” while specific identification can promote possible income manipulation.  It is only under FIFO that net income manipulation is not possible.

CEO – 2 – CFO [Case Model]

“Let’s go with FIFO,” the new administrator said to his Chief Financial Officer, Bert. “The profits will make us look good to the home office and we can always switch back to LIFO if inflation starts back-up again, right Bert?” He mused, but he was not amused because freedom of choice does not include changing DME inventory methods every few years, especially if only to report higher income. “The switching of methods violates the basic tenet of consistency, which requires the use of the same inventory cost and accounting methods in preparing financial reports and statements,” Bert emphatically stated.

Key Issues

1) Is this sort of inventory costing and maneuvering permissible?

2) What is its justification?

3) How is it notated in financial reports?

4) Is this sort of thing ethical?

Assessment

“The switching of methods violates the basic tenet of consistency, which requires the use of the same inventory cost and accounting methods in preparing financial reports and statements,” Bert emphatically stated.

Conclusion

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Filed under: "Advisors Only", "Ask-an-Advisor", Accounting, CMP Program, Ethics, Practice Management, Taxation | Tagged: cost accounting, costing methods, DME, durable medical equipment, FIFO, inventory costing methods, inventory management, LIFO, specific identification | 7 Comments »