Water Products Corporation has been supplying high-quality bathroom fixtures to its customers for several decades and uses a LIFO inventory system. Rapid increases in the cost of fixtures have resulted in inventory values substantially below current replacement cost. To bring its inventory carrying costs up to more reasonable levels, Water Products sold its entire inventory to Plumbers Products Corporation and purchased an entirely new supply of inventory items from Growinkle Manufacturing. Water Products owns common stock of both Growinkle and Plumbers Products.

Research Water Products' external auditor immediately pointed out that under some ownership levels of these two companies, Water Products could accomplish its goal and under other levels it could not.

Required:

Explain to Water Products' president the effects of intercompany transfers on the valuation of inventories and discuss the effects that different ownership levels of Growinkle and Plumbers Products would have on the success of Water Products' plan. What are some possible ethical considerations involved, if any?