An executive in a merchandising company receives an annual bonus equal to 5% of net income

The reduction in inventory can help the firm by reducing the working capital requirement and also inventory days on hand. Inventory is part of the current assets for the firm and hence it is used in calculation of working capital. Working capital is the difference between current assets and current liabilities. The lower the inventory the lower is the working capital needed and it’s financing costs.

Changing from LIFO to FIFO during price increasing time will increase the net income for the period. The reason being FIFO uses the latest lot purchased in inventory valuation and earlier lower price purchased lots are charged to cost of goods sold. The higher the net income it helps the executive personally since he gets annual bonus equal to 5% of net income.

The accounting method for inventory valuation is part of the accounting policy of the firm. The accounting policy should be applied consistently from one period to another period. The change in inventory valuation method has to be accounted retrospectively and all material disclosures should be made in notes to account. Hence the proposal to move from LIFO to FIFO can be approved as one time. It cannot be changed year on year basis.