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Financial Accounting > 4. Inventories > Flashcards

4. Inventories Flashcards

1
Q

Inventory cost flow is a major determinant of what?

A

Net income for merchandising and manufacturing companies.

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2
Q

What are significant assets on the balance sheets of merchandising and manufacturing companies?

A

Inventories.

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3
Q

What methods are used to account for inventory under IFRS and US GAAP?

A

IAS 2 for IFRS and Topic 330 for US GAAP.

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4
Q

How does the choice of inventory accounting method affect financial statements?

A

It results in different values for cost of goods sold and inventory.

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5
Q

What qualifies as inventories?

A

Assets held for sale, in production, or materials/supplies for production or service.

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6
Q

How are inventories measured under IFRS?

A

At the lower of cost and net realizable value.

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7
Q

What are the components of the cost of inventories under IFRS?

A

Costs of purchase, costs of conversion, and other costs to bring inventories to their location and condition.

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8
Q

What is net realizable value?

A

Estimated selling price minus estimated costs to make the sale.

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9
Q

What is excluded from the cost of inventories?

A

Abnormal wasted materials, storage costs, administrative overheads not contributing to inventory location, selling costs, and foreign currency losses.

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10
Q

Which inventory accounting method is allowed only under US GAAP?

A

LIFO (Last In, First Out).

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11
Q

What percentage of US companies use the LIFO method and why?

A

Approximately 30%, mostly due to potential income tax savings.

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12
Q

What happens to financial statements when LIFO is used during rising costs?

A

Gross profit, operating profit, and income before taxes are lower, income tax is reduced, and net operating cash flow increases.

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13
Q

What must companies disclose when using the LIFO inventory method?

A

The amount of the LIFO reserve or the difference between FIFO and LIFO inventory values.

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14
Q

How does using LIFO affect profitability, liquidity, and solvency ratios?

A

It materially affects these ratios, often requiring a restatement to FIFO for comparison with other companies.

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15
Q

What is the impact of FIFO in an environment of increasing inventory costs?

A

It allocates a lower cost of goods sold on the income statement and reflects current replacement values.

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16
Q

What are the costs of purchase under IFRS?

A

Purchase price (less discounts), import duties, taxes, transport, handling, and other costs directly attributable to acquiring goods.

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17
Q

What are costs of conversion under IFRS?

A

Direct labor, fixed and variable production overheads incurred in converting materials into finished goods.

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18
Q

What is the allocation of fixed production overheads based on?

A

Normal capacity of the production facilities.

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19
Q

When are other costs included in the cost of inventories under IFRS?

A

When they are incurred in bringing inventories to their present location and condition.

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20
Q

What does the market value represent under US GAAP for inventories?

A

Current replacement cost, not greater than net realizable value and not less than net realizable value reduced by a normal sales margin.

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21
Q

When is a write-down required under IFRS?

A

When the value of inventory declines below its historical cost.

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22
Q

What happens when inventory previously written down increases in value under IFRS?

A

A reversal of the write-down is required, limited to the original write-down amount.

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23
Q

What is the financial statement effect of a write-down under IFRS?

A

The write-down is recognized as an expense in the period it occurs.

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24
Q

What inventory cost formulas are permitted under both IFRS and US GAAP?

A

FIFO and weighted average cost.

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25
Q

How are non-interchangeable inventory items accounted for under IFRS and US GAAP?

A

By using specific identification of individual costs.

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26
Q

When must the net realizable value of inventory be reassessed?

A

In each subsequent period.

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27
Q

What costs are excluded from the cost of inventories under IFRS?

A

Abnormal wasted materials, labor, storage costs (unless necessary before further production), administrative overheads, selling costs, and foreign currency losses.

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28
Q

How are costs of purchase calculated under IFRS?

A

Purchase price minus discounts, plus import duties, taxes, transport, and handling costs.

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29
Q

What does the cost of conversion include?

A

Direct labor and production overheads incurred in converting materials into finished goods.

30
Q

When can different cost formulas for inventories be justified under IFRS?

A

When inventories have a different nature or use.

31
Q

How is the net realizable value calculated?

A

Estimated selling price minus costs of completion and selling costs.

32
Q

How is market value defined under US GAAP?

A

Current replacement cost, but not higher than net realizable value and not lower than net realizable value minus normal sales margin.

33
Q

What are companies required to disclose when using LIFO under US GAAP?

A

The LIFO reserve, which is the difference between the FIFO and LIFO inventory values.

34
Q

What is the purpose of disclosing the LIFO reserve?

A

To allow analysts to compare companies using LIFO with those using FIFO.

35
Q

What happens to net operating cash flow when using LIFO during rising costs?

A

It increases due to lower income tax expenses.

36
Q

How does LIFO impact working capital and total assets on the balance sheet?

A

LIFO results in lower inventory carrying values, reducing both working capital and total assets.

37
Q

How does LIFO affect gross profit, operating profit, and income before taxes during rising costs?

A

It lowers gross profit, operating profit, and income before taxes.

38
Q

Why do some U.S. companies prefer the LIFO method?

A

For potential income tax savings.

39
Q

How does the LIFO method affect financial ratios?

A

It materially affects profitability, liquidity, activity, and solvency ratios.

40
Q

What is the impact on financial statements when using LIFO compared to FIFO?

A

LIFO results in lower inventory values, lower gross profit, and lower total assets, affecting key financial metrics.

41
Q

Why is restating to FIFO important for analysts?

A

To make valid comparisons with companies using FIFO.

42
Q

What is the treatment of inventories held for firm sales contracts under IFRS?

A

They are valued based on the contract price.

43
Q

When are costs excluded from the cost of inventories under IAS 2?

A

When they involve abnormal waste, storage costs, administrative overheads, selling costs, or foreign currency losses.

44
Q

What must companies using LIFO under US GAAP disclose in their financial notes?

A

The amount of the LIFO reserve or the difference between FIFO and LIFO inventory values.

45
Q

What are the three primary inventory accounting methods under both IFRS and US GAAP?

A

FIFO, weighted average cost, and specific identification.

46
Q

How often is the net realizable value of inventory reassessed?

A

In each subsequent reporting period.

47
Q

What is the definition of inventories under IAS 2?

A

Inventories are assets held for sale, in production for sale, or materials and supplies used in production or service.

48
Q

How does the IFRS define the cost of inventories?

A

Costs of purchase, conversion, and other costs incurred to bring the inventories to their location and condition.

49
Q

What are the components of costs of purchase?

A

Purchase price (minus discounts), import duties, taxes, transport, handling, and other direct acquisition costs.

50
Q

What are the components of costs of conversion?

A

Direct labor and production overheads.

51
Q

What is the purpose of including non-production overheads in inventory costs under IAS 2?

A

To cover costs incurred in bringing inventories to their current location and condition.

52
Q

What is net realizable value under IAS 2?

A

The estimated selling price in the ordinary course of business minus the costs to complete and sell the inventory.

53
Q

Under IFRS, how are costs that do not contribute to bringing inventories to their location treated?

A

They are excluded from the cost of inventories.

54
Q

What is the role of normal capacity in allocating fixed production overheads?

A

Normal capacity is used to allocate fixed overheads to the costs of conversion.

55
Q

What must be done when inventory value declines below historical cost under IFRS?

A

A write-down must be recorded and disclosed.

56
Q

Can a write-down of inventory be reversed under IFRS?

A

Yes, but only up to the amount of the original write-down.

57
Q

What does US GAAP define as market value for inventories?

A

Current replacement cost, not greater than net realizable value and not less than net realizable value minus a normal profit margin.

58
Q

What does US GAAP allow that IFRS does not in inventory accounting?

A

The use of the LIFO (Last In, First Out) method.

59
Q

What happens if inventory is sold under IAS 2?

A

The carrying amount of the inventory is recognized as an expense.

60
Q

How does FIFO affect inventory valuation during periods of rising costs?

A

FIFO allocates a lower cost of goods sold and reflects current replacement values.

61
Q

What is required for inventories of items that are not interchangeable under both IFRS and US GAAP?

A

The specific identification of their individual costs.

62
Q

What cost formula must be used for inventories with a similar nature and use?

A

The same cost formula, such as FIFO or weighted average cost.

63
Q

What is the impact of using LIFO during periods of rising inventory costs?

A

It increases the cost of goods sold, reduces taxable income, and lowers net income.

64
Q

How do rising costs affect the comparison between LIFO and FIFO methods?

A

LIFO results in higher costs of goods sold and lower profits, while FIFO shows lower costs and higher profits.

65
Q

Why is the LIFO method not allowed under IFRS?

A

Due to differences in how it affects income and inventory valuation compared to other methods like FIFO and weighted average cost.

66
Q

What must a company disclose if they use the LIFO method under US GAAP?

A

The LIFO reserve, which is the difference between the FIFO and LIFO inventory values.

67
Q

What is included in the cost of inventories under US GAAP?

A

Costs of purchase, conversion, and other costs incurred to bring the inventories to their present location and condition.

68
Q

How is “market” defined in relation to inventory under US GAAP?

A

Market is defined as the current replacement cost, subject to limits based on net realizable value.

69
Q

What does a write-down of inventory affect under IFRS?

A

It reduces the carrying value of inventory and is recognized as an expense.

70
Q

What conditions trigger the reassessment of inventory’s net realizable value?

A

It is reassessed at the end of each reporting period.

Financial Accounting (8 decks)

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