At the beginning ot the year, Breidel Company changes its inventory accounting method (for both financial and tax reporting) from first in first out to average cost. Assuming an environment of increasing prices, how will this accounting change affect Breidel’s forecasts of its net cash position?
Changing the inventory accounting method has no immediate cash flow effects and therefore should not change a firms short-term forecast (typically 4 to 6 weeks) of its net cash position. However, because the average cost inventory method will result in lower gross profit compared to FIFO, it will also result in decreased taxes. The firms long-term forecast (typically 3 to 5 years) of its net cash position should reflect a decrease in cash outflows for taxes, and consequently greater net cash in future periods.