How Can Ethics Influence a Company's Accounting Decisions?

Ethics is important in business, both for company integrity and stockholder trust in the firm. There are a number of different accepted accounting methods that can artificially affect company profits in the short term. Unethical companies might use those tactics to inflate profits for a quarter or fiscal year with none being the wiser.

FIFO

FIFO (first in, first out) is an accounting strategy that a company can use to affect profits. By way of formal definition, FIFO is an "accounting system used to value inventory for tax purposes," according to Entrepreneur. Switching its accounting method to FIFO allows a company to subtract inventory valuation from the oldest inventory items in stock. This typically increases profits, because older inventory is generally worth less due to inflation -- providing an artificial boost in profits for the year.

LIFO

LIFO (last in, first out) is another accounting strategy that an unethical firm can use to affect profits. Here, the most recent inventory items purchased are deducted from company earnings first, making this useful if the company has recently acquired a lot of inventory for little cost. This allows them to move it as quickly as possible from the books for a boost in earnings.

Average Cost

Average cost is the only accounting method that is fairly ethics-proof. This takes the average cost of the entire inventory into account when writing the books, preventing companies from making snap changes to affect earnings reports.

Repo Method

Unethical banks use the repo method to get bad debt off the books, or to hide debt, thus preventing investors from seeing debt on the balance sheet for the existing quarter. Be wary of banks that utilize this accounting technique.

References

• Investopedia: Inventory Valuation for Investors: FIFO and LIFO
• Wall Street & Technology: Banks Using Unethical Accounting?