Capitalism is the system where private investors and merchandise producers drive the country's economy for profits without much restrictions from the government. In a capitalistic economy, the amount of goods produced is highly influenced by the demand for the goods and the supply level ( Blasi et al., 2018) . Moreover, the government does not determine produced goods, making a capitalistic market a free economy.
Various valuation methods have different effects on the financial statement of a company. For instance, FIFO valuation dictates that the first units of produced goods are the first to be sold. Therefore, if the market prices increase, the inventory cost is reduced as the goods were made at a lower cost. However, if the market prices decline, the inventory cost rises as the goods were produced at a higher cost (Wei et al., 2015). Lower inventory cost led to tax liability and higher net income as the inventory values are more significant in the balance sheet. The retained earnings in the equity statement go up as high net income increases the retained earnings.
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LIFO valuation method accounts for inventory in that the most recently produced goods are sold first. Therefore, when the market prices increase, the cost of goods will be higher, resulting in lower net income and lower taxes (Wei et al., 2015). Under LIFO, when the market prices increase, the value of inventory in the balance sheet is lower than that of FIFO since goods are sold at a lower price than the cost of manufacturing. Therefore, it reduces the earnings in the equity statement. However, when the inflation level goes down, there is an opposing reaction in the financial reports. The Weighted Average method gives a value in between FIFO and LIFO’s valuation.
The inventory valuation method selected influences competition in a capitalistic market by impacting the debt to equity ratio. For example, when the capital is low, the ratio increases, and when it high, the rate lowers (Wei et al., 2015). Thus, under FIFO, the debt to equity ratio will be more substantial than in LIFO. Under FIFO valuation, banks are more willing to provide credit to companies than LIFO due to lower debt to equity ratios.
References
Blasi, J. R., Kroumova, M., & Kruse, D. (2018). Kremlin Capitalism: Privatizing the Russian economy . Cornell University Press.
Wei, L., Qin, H., Zhu, W., & Wan, L. (2015). A study of perturbation operators for the pickup and delivery traveling salesman problem with LIFO or FIFO loading. Journal Of Heuristics , 21 (5), 617-639.
