Tao & Willis, Inc.: Inventory Accounting Methods

Abstract

An executive with Tao & Willis, Inc. (TW), is faced with choosing an inventory accounting method for a new Brazilian subsidiary of a U.S.-based company. Students are asked to assess the different profit implications of LIFO and FIFO for five years of data. During the time period, exchange rates between Brazil and the United States had been fluctuating significantly. This case focuses on the basics of inventory accounting in an interesting international context, and can be used in graduate or undergraduate business courses, specifically those teaching the fundamentals of financial accounting. Excerpt UVA-C-2384 Rev. Sept. 15, 2016 Tao & Willis, Inc.: Inventory Accounting Methods Tao & Willis, Inc. (TW), was a video gaming and entertainment company headquartered in Phoenix, Arizona. The company specialized in the manufacture and distribution of computer games and stand-alone gaming consoles. It sold its products all over the world, and experienced particularly strong demand in South America. High import tariffs in those countries, however, were cutting into profits. Under the leadership of John Gary Sommers, TW had become proactive. For years, Sommers had lobbied senior management to move manufacturing operations to Brazil, and his vision was finally a reality. The new subsidiary, TW-Brazil, would handle all manufacturing operations in the Western hemisphere south of the equator. TW had never before operated an entity in a foreign country, so this represented a true inflection point for the company. Sommers was put in charge and given full decision-making responsibility for all financial and operational aspects of TW-Brazil. One of the early tasks Sommers assigned his CFO was to evaluate TW-Brazil's financial options related to inventory accounting. He specifically wanted comparisons of expected financial results for two different inventory cost flow methods: last in, first out (LIFO), and first in, first out (FIFO). Sommers knew that the inventory cost flow method that he ultimately chose would influence profits. TW was a publicly traded company and was thus always focused on maintaining margins and meeting EPS growth expectations. TW-Brazil was expected to help in this regard in 2016, but the longer-term benefits were not as obvious. Sommers fully understood that there was a company-wide expectation that 30% gross margins be maintained. . . .