Golf Challenge Corp is a retail sports store carrying golf a

Golf Challenge Corp. is a retail sports store carrying golf apparel and equipment. The store is at the end of its second year of operation and is struggling. A major problem is that its cost of inventory has continually increased in the past two years. In the first year of operations, the store assigned inventory costs using LIFO. A loan agreement the store has with its bank, its prime source of financing, requires the store to maintain a certain profit margin and current ratio. The store’s owner is currently looking over Golf Challenge’s primary financial statements for its second year. The numbers are not favorable. The only way the store can meet the required financial ratios agreed on with the bank is to change from LIFO to FIFO. The store originally decided on LIFO because of its tax advantages. The owner recalculates ending inventory using FIFO and submits those numbers and statements to the loan officer at the bank for the required bank review. The owner thankfully reflects on the available latitude in choosing the inventory costing method.

1- How does Golf Challenge’s use of FIFO improve its net profit margin and current ratio?

2- Is the action by Golf Challenge’s owner ethical? Explain.

Solution

1- How does Golf Challenge’s use of FIFO improve its net profit margin and current ratio?

Ans. Valuation of Inventory

A Corprate organization that produces & purchases good for resale should have accurately known the ending inventory in its hands. there is accounting standard or accounting principle thats allows to organization to use different inventory valuation mathods like FIFO LIFO or weighted average simple average etc.

In FIFO Mathod its assume that first purchase unit of inventory firstly sold And In LIFO Mathod last unit purchase of inventory firdtly sold.

Impact on Profit Margin & Current Ratio

Inventory mathod of the company uses affect the its costs of good sold as well as opening and closing inventory which finally have impact on gross profit or net profit.

COGS= opening stock+ purchase-closing stock

if FIFO Mathod on inventory valautaion is used to report lower cost of good sold which leads to increase total gross margin ( Sale - COGS) and its increase the net profit margin vice versa in case of LIFO

This mean that earning per share is higher using FIFO as compare to LIFO

Impact on Current ratio

Inventory mathod of company affect the closing inventory showing in balance sheet which leads to increase or decrease in current assets. Company using FIFO Mathod of Inventory valuation report the higher closing inventory, which result higher current ratio. vise versa in case of LIFO

2- Is the action by Golf Challenge’s owner ethical? Explain.

Ans, yes action taken is ethical

Golf Challenge’s owner are required to disclose all significant changes in accounting policies in its financial statments through comply the accounting’s full-disclosure principle. As a result, the business’s financial statements would need to inform prospective investors that there was a shift from LIFO to FIFO as well as detail what the effect of that shift could be.