Purchase Solution

What is managements incentive to choose FIFO or LIFO?

Not what you're looking for?

Ask Custom Question

I would like to see if I am on the right track with my answers to the following questions about FIFO/LIFO, etc.

(See attached file for full problem description)
---
A retail company begins operation late 2000 by purchasing $600,000 of merchandise. There are no sales in 2000. During 2001 additional merchandise of $3,000,000 is purchased. Operating expenses (excluding management bonuses) are $400,000, and sales are $6,000,000. The management compensation agreement provides for incentive bonuses totaling 1% of the after-tax income (before bonuses). Taxes are 25%, and accounting a taxable income will be the same.

The company is undecided about the selection of LIFO or FIFO inventory methods. For the year ended 2001, ending inventory would be $700,000 and $1,000,000 respectively under LIFO and FIFO.

How are accounting numbers used to monitor this agency contract between owners and managers?

Evaluate management's incentive to choose FIFO.

Evaluate management's incentive to choose LIFO.

Assuming an efficient capital market, what effect should the alternative policies have on security prices and shareholder wealth?

Why is the management compensation agreement potentially counter-productive as an agency-monitoring mechanism?

Devise an alternative bonus system to avoid the problem in the existing plan.
---

(See attached file for full problem description)

Attachments
Purchase this Solution
Solution Summary

This solution discusses LIFO and FIFO in 815 words.

Solution Preview

A retail company begins operation late 2000 by purchasing $600,000 of merchandise. There are no sales in 2000. During 2001 additional merchandise of $3,000,000 is purchased. Operating expenses (excluding management bonuses) are $400,000, and sales are $6,000,000. The management compensation agreement provides for incentive bonuses totaling 1% of the after-tax income (before bonuses). Taxes are 25%, and accounting a taxable income will be the same.

The company is undecided about the selection of LIFO or FIFO inventory methods. For the year ended 2001, ending inventory would be $700,000 and $1,000,000 respectively under LIFO and FIFO.

Let us consider the figures for 2000 and 2001. The purchases made in 2000 are 600,000; the purchases made in 2001 are 3,000,000 giving us total purchases of 3,600,000. If we add the operating expenses to this we get a total cost of 4,000,000. Now the total sales are 6,000,000.
If we use FIFO then the value of inventory deducted from the total cost will be 1,000,000 so the taxable income will be 6,000,000 - 3,000,000 = 3,000,000. The taxes will be @ 25% that is 750,000 giving us 2,250,000. Calculated on this the bonus will be @ 1% that is 22,500 and the net ...

Purchase this Solution
Free BrainMass Quizzes
Income Streams

In our ever changing world, developing secondary income streams is becoming more important. This quiz provides a brief overview of income sources.

Operations Management

This quiz tests a student's knowledge about Operations Management

Motivation

This tests some key elements of major motivation theories.

Marketing Research and Forecasting

The following quiz will assess your ability to identify steps in the marketing research process. Understanding this information will provide fundamental knowledge related to marketing research.

Accounting: Statement of Cash flows

This quiz tests your knowledge of the components of the statements of cash flows and the methods used to determine cash flows.

View More Free Quizzes
Related BrainMass Solutions

  • How are accounting numbers used to monitor this agency contract between owners and managers?

    The management's incentive to choose FIFO is to get a higher income after taxes of $2,250,000 and so qualify for a larger bonus of $22,500. Evaluate management's incentive to choose LIFO.

  • Total cost of sales and ending inventory

    #2 and #3 questions are to be answered as such. 2. Evaluate management's incentives to choose FIFO. 3. Evaluate management's incentives to choose LIFO. b. Format for FIFO and LIFO ? Sales ? - Cost of Sales ? = Gross margin ?

  • LIFO and FIFO Inventory Methods

    The company is undecided about the selection of the LIFO or FIFO inventory methods. For the year ended 2001, ending inventory would be $700,000 and $1,000,000 respectively under LIFO and FIFO.

  • Finance: Evaluate incentives for FIFO or LIFO; effect to shareholders

    How are accounting numbers used to monitor this agency contract between owns and managers? Evaluate management's incentives to choose FIFO. Evaluate management's incentives to choose LIFO.

  • Choosing LIFO or FIFO for inventory

    The solution explains the impact of LIFO or FIFO method on net income

  • management compensation agreement

    The company is undecided about the selection of the LIFO or FIFO inventory methods. For the year ended 2001,ending 2001,ending inventory would be $700,000and 1,000,000 respectively under LIFO and FIFO.

  • FASB Disclosures regarding inventory, agency and security

    Thus, in this case the accounting numbers determine the incentives to the managers, hence what method for generating the accounting numbers is used is very important. Evaluate management's incentives to choose FIFO and also to choose LIFO.

  • Accounting

    Hence, it can be concluded that management have to select the FIFO inventory method as it gives is better or high bonuses as compare to LIFO.

  • FASB, Investors, and Disclosure

    =Bonus What is the total cost of sales and ending inventory numbers to determine the cost of sales for (1) LIFO and (2) FIFO methods See excel sheet attached 4.

View More Related Solutions