Your friend D. Vadar has become the Accounting Czar of the great country, Endor. His first problem deals with the accounting of inventory. Endor, has used the direct costing method for inventory and has allowed only FIFO Furthermore, Endor rather than using lower of cost or market requires inventory to be valued at replacement cost whether higher or lower and the adjustment goes to comprehensive income but not actual income. Vadar is considering inventory alternatives for financial reporting.

Under current tax policies in Endor, companies can use only fifo for taxes. Jabba-the-Hut the Secretary of the Treasury, and cousin of the President, has stated that she will require the company to use the same method on their tax return that they use for financial reporting. In addition, currently the Endor tax code requires using replacement cost for valuing inventory; if this causes inventory to be written up this appreciation IS included in taxable income; however; write-downs for taxes are NOT allowed. Hence for taxes Endor has HIGHER of cost or market!

H. Solo, a highly respected entrepreneur has suggested to Vadar that Endor should switch its inventory accounting from direct to absorption. He noted that both IFRS and US GAAP require this method for external reporting. He believes that comparability of Endors statements with those of these two governing bodies would only help attract foreign investors. He also argues that absorption forces companies to look at the long-run costs of production. Furthermore, H. Solo wants Endor to permit lifo so that he pays less in taxes which gives him more to invest in his business. Knowing that the taxing authority will follow the same rules as GAAP, Solo wants Lower of cost or market following the US approach where all 3 definitions of market are examined, and this write-down goes against income.

Ms. Leah, head of the major union in Endor strongly opposes the switch to absorption costing. She is concerned that companies will produce more than they sell in the early years of operations thus reporting higher income (or more likely smaller losses) and then when established produce less than they sell which reduces income which reduces the profit sharing granted to the well deserving union employees. Furthermore, Ms. Leah wants Endor to keep FIFO as the only option for companies for that same reason. Ms. Leah also points out that direct costing does not allow income manipulation and by showing inventory at the cost of making the next one (variable cost) it encourages better decision making with respect to special orders. It would also make our inventory with a lower cost which should encourage foreign investment and with that more union jobs. Leah also wants Endor to use the tax treatment for valuing inventory; if the inventory has appreciated; show it as income so there are more profits for the well deserving union members; however, if it has declined in value the inventory remains at its original cost with no write down of inventory or income. She believes that with write-downs going against income, vendors will be pressured to show unrealistically low prices for inventory at year end so income can be reduced thus reducing or eliminating bonuses for employees.

Professor Obi-Won, loves comparability, therefore he doesnt like companies to have choices. We have only been allowing FIFO, lets keep it that way. Because the price of items change based on the number produced with absorption costing, Obi-Won insists on keeping direct costing. Knowing that different vendors charge different prices and the same vendor may change their price based on the quantity purchased, Obi-Won wants NO adjustments to the price of the inventory based on current market prices.

REQUIRED: WRITE A MEMO TO YOUR FRIEND D. VADAR AND OUR 3 DISTINGUISHED CITIZENS OF ENDOR GIVING YOUR SUGGESTIONS WITH RESPECT TO INVENTORY. MAKE SURE YOU MEMO ADDRESSES THE CONCERNS OF EACH OF THESE DISTINGUISHED CITIZENS OF ENDOR.