In 2010 the Moncrief Company purchased from Jim Lester the right to be the sole distributor in the western states of a product called Zelenex. In payment, Moncrief agreed to pay Lester 20% of the gross profit recognized from the sale of Zelenex in 2011. If Moncrief purchases the additional units at year end under a periodic LIFO inventory system, Moncrief reduces Jim Lester’s payment by $40,000 ($210,000 ‘ $170,000) and decreases gross profit by $200,000 ($1,050,000 ‘ $850,000). The net effect on before-tax income is a decrease of $160,000 ($200,000 ‘ $40,000). Since Moncrief does not intend to sell the units until 2004, the only logical reason for purchasing more costly inventory at year-end is profit manipulation. Should Moncrief exercise its right to purchase inventory at will, resulting in a reduction in net income, or recognize the rights of Jim Lester to receive profit for the sale of his product, shareholders’ rights to have their investment appreciate through positive earnings, and government entities’ rights to collect tax on economic net income? Why?
