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Financial Accounting > Chapter 6 - Inventories, Accounts Payable, and Long-Term Assets > Flashcards

Chapter 6 - Inventories, Accounts Payable, and Long-Term Assets Flashcards

1
Q

Inventory Analysis Tools (I-AT)

A

My notes

I-AT: Inventory - Analysis Tools

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2
Q

I-AT | Cash Conversion Cycle (CCC)

A

Defined as:

Days sales outstanding (account receivable)

+ Days inventory outstanding

  • Days payable outstanding

= CCC

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3
Q

PPE Assets - Capitalization and Depreciation

A

When PPE is acquired, it is recorded at cost on the BS

This is called capitalization, which explains why expenditures for PPE are called CAPEX

Leased assets are included int he company’s PPE, even though not “owned”

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4
Q

PPE | Plant and Equipment

A

Once capitalized, the cost of plant and equipment is recognized as expense over the period of time that the asset produces revenues (directly or indirectly). This is called Depreciation

Land does not have a determinable useful life and is therefore not depreciated

3 estimates to determine depreciation expense

  1. Useful life - period of time over which the asset is expected to generate measurable benefits
  2. Salvage value - what it’s worth when you get rid of it
  3. Depreciation method - the estimate of how the asset is used up over its useful life

When the asset is sold, the difference b/t the sales proceeds and its book value is recorded as gain or loss on sale in the IS

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5
Q

Depreciation | Straight-Line Method

A

Depreciation is recognized evenly over the estimated useful life of the asset

2 Components:

  1. Depreciation Base
  2. Depreciation Rate

Depreciation Base = Cost - Salvage value

Depreciation Rate = 1 ÷ Estimated useful life (1/eul)

Note: Net PPE is the dr; accumulated depreciation (contra-asset) is cr (and is a neg on IS)

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6
Q

Accumulated depreciation & NBV

A

The sum of all depreciation expense that has been recorded to date.

The net book value (NBV), or carrying value,is cost less accumulated depreciation

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7
Q

Depreciation | Other Methods

A

Accelerated depreciation records more depreciation in the early years of an asset’s useful life and less in later years

Units-of-depreciation records depreciation according to asset use. Depreciation base is cost less salvage value, deprecation rate is the units produced and sold during the year compared with the total expected units to be produced and sold

Modified Accelerated Cost Recovery System (MACRS), an accelerated method, is required by the US IRS to calculate taxable income

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8
Q

Research & Development Facilities and Equipment

A

R&D facilities and equipment are not immediately expensed. They are capitalized on the BS and depreciated over their useful life

Only those R&D facilities and equipment that are purchased specifically for a single R&D project, adn have no alternative use, are expensed immediately in the IS (highly unusual). These are not capitalized. The rationale is:

  • It’s uncertain whether any tangible projects or services will be developed
  • The timing of future products and services is uncertain
  • Salaries for R&D personnel are no different than for other personnel whose salaries and wages are expensed when incurred
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9
Q

PPE Assets | Asset Sales

A

Gain or Loss on Asset Sale = Proceeds from Sale - Net Book Value of Asset Sold

When sold:

  • Acquisition cost and related accumulated depreciation are both removed from the BS
  • Any gain or loss is reported in income from continuing operations
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10
Q

PPE Assets | Asset Impairments

A

Impairment of PPE assets is determined by comparing the asset’s net book value to the sum of the asset’s expected future (undiscounted) cash flows.

If expected cash flows are less than net book value, then the asset is deemed impared.

To recognize an impairment charge:

  • Reduce the asset by the amount of the write-down
  • Recognize the loss in the IS
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11
Q

PPE Assets | Restructuring Costs (Disclosure of)

A

Require enhanced disclosure either as a separate line item in the IS or as a footnote

Typically includes 3 components:

  1. Employee severance or relocation costs
  2. Asset write-downs
  3. Other restructuring costs

To use the term restructuring, a company is required to have a formal restructuring plan that is approved by its board of directors

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12
Q

Employee severance or relocation costs

A

Represents accrued (estimated) costs to terminate or relocate employees as part of restructuring

The company must:

  • Estimate total costs of terminating or relocating selected employees (includes severance pay, outplacement, relocation or retraining)
  • Report total estimated costs as an expense (and a liability) in the period the restructuring program is announced
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13
Q

Asset write-downs

A

Write-dwon of assets whose fair value is less than book value

No cash flow effect unless the write-down has tax consequences

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14
Q

Other restructuring costs

A
  • Vacating duplicative facilities
  • Fees to terminate contracts, Exit costs such as legal and asset-appraisal fees

Companies estimate and accrue these costs and reduce the restructuring liability as those costs are paid in cash

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15
Q

PPE Assets | Restructuring Costs (Analysis of)

A

Analyzing employee severance or relocation costs and other costs

  • Companies are allowed to record costs relating to employee separation or relocation that are incremental and that do not benefit future periods
  • Other accrued costs must be related to the restructuring and not to expenses that would otherwise have been incurred in the future

Analyzing asset write-downs

  • Accelerate (or catch up) the depreciation process to reflect asset impairment
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16
Q

PPE Assets - Analysis Tools (PPE A-AT)

A

just a place holder to define the title and its Acronym

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17
Q

PPE A-AT | PPE Turnover

A

Defined as follows:

PPE Turnover (PPET) = Sales / Average PPE, net

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18
Q

PPE A-AT | PPE Useful Life

A

Estimate the average useful life for depreciable assets as follows:

Average useful life = Average depreciable asset cost / Depreciation expense

We compute depreciable assets by excluding two items from gross PPE

  1. Land, which is never depreciated
  2. Construction in progress, which is not depreciated until the assets under construction are completed and placed into service
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19
Q

PPE A-AT | PPE Percent Used Up

A

This ratio reflects the percent of depreciable assets that are no longer productive and is computed as follows:

Percent used up = Accumulated depreciation / Average depreciable asset cost

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20
Q

What is Depreciation?

A

Depreciation is cost allocation. (i.e. matching some part of the original amount paid to a period in time)

Depreciation expense is an IS item

Accumulated Depreciation is a BS item

PPE is BS

2 things we need to Estimate depreciation

  1. Useful life - n
  2. Salvage value - sv
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21
Q

Financial Accounting Methods of Depreciation

A

There are currently 4 mthods we are using (in this class)

  1. Straight-line (SL)
  2. Sum of the years’ digits (SYD)
  3. Double Declining Balance (DDB)
  4. Units of Production
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22
Q

Sale of a Fixed Asset

A

(see image)

Note: The write-off in either example is the same.

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23
Q

Changes in Estimates

A

see image

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24
Q

Change in Depreciation Methods

A

Considered a Change in Estimate

You must disclose the following

  1. Impact on net income
  2. Justification (accounting)
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25
Q

Define and list the Inventory Costing Methods

A

Costing Methods are methods used by management to determine which costs should be removed from the balance sheet and reported as cogs in the income statement

  • FIFO - First-In, First-Out
  • LIFO - Last-In, First-Out
  • Average Cost (AC)
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26
Q

Describe the Flow of Costs for Inventory Expenditures

A

Inventory expenditures follow the “Costs capitalized” line at the top of the graphic (attached)

  • Cost of inventory is added to the Balance Sheet as an asset (captialized) when it is purchased or manufactured
  • Inventory cost is transferred from the balance sheet to the Income Statement as cost of goods sold (COGS) when sold.
  • COGS is deducted from sales to yield gross profit
27
Q

Describe Inventory Cost Flows to Financial Statements

A
28
Q

Costing Methods | FIFO

A

The FIFO methos transfers costs from inventory in the order that they were initially recorded.

29
Q

Costing Methods | LIFO

A

The LIFO method transfers the most recent inventory costs from the BS to COGS.

30
Q

Costing Methods | Average Costs (AC)

A

The AC method computes the cost of goods sold as an average of the cost to purchase or manufacture all the inventories that were available for sale during the period.

Commonly adopted when inventory purchases and sales are continuous during the year (especially retail companies

31
Q

Business Insight | Retail Inventory Method

A

Must know cost of inventory and the retail selling price.

From this, you calculate the cost-to-retail percentage

Applies that percentage to estimate the cost of the inventory still available at EOY

32
Q

Income Statement Effects (of Inventory Costing)

A

All three methods yield different Gros Profit numbers because they use different methods of accounting for Cost of Goods Sold.

FIFO has a higher gross profit becasue it matches older lower-cost inventory against current selling prices.

In an inflationary environment, FIFO yields higher gross profit than do LIFO or AC methods

33
Q

Balance Sheet Effects (of Inventory Costing)

A

Ending inventory using LIFO is less than when using FIFO

In periods of rising costs, LIFO inventories are markedly lower than under FIFO

The difference between FIFO and LIFO inventories is called the LIFO reserve.

34
Q

Cash Flow Effects (of Inventory Costing)

A

When inventory costs rise, the LIFO method yields a lower net income

Inventory costing methods affect taxable income

Using LIFO reduces increases COGS, which reduces taxable income and taxes paid. The net result is a real cash savings

35
Q

Inventory Reporting | Lower of Cost or Market (LCM)

A

A method of inventory reporting where a company tracks both FIFO and RIM and then uses the lower of the two.

When RIM yields a lower total, there are two financial statement effects:

  1. Inventory book value is written down to current market value (replacement cost), reducing inventory and total assets
  2. Inventory write-down is reflected as an expense (part of cogs) on the IS, reducing the current period gross profit, income, and equity
36
Q

LIFO Reserve Adjustments to Financial Statements

& the 3 Balance Sheet Adjustments for a LIFO Reserve

A

Equation: FIFO Inventory = LIFO Inventory + LIFO Reserve

LIFO reserve must be reported

37
Q

What are the 3 Balance Sheet Adjustments for a LIFO Reserve

A

3 Balance Sheet Adjustments for a LIFO Reserve

  1. Increase inventories by the LIFO reserve
  2. Increase tax liabilities by the tax rate applied to the LIFO reserve
  3. Increase retained earnings for the difference
38
Q

Equation for IS Adjustments for a LIFO Reserve

A

FIFO COGS = LIFO COGS - Increase in LIFO Reserve (or + Decrease)

When using LIFO, you must adjust cogs from LIFO to FIFO

39
Q

LIFO Liquidations

A

The increase in gross profit resulting from a reduction of inventory quantities in the presence of rising costs.

40
Q

Define Gross Profit Margin (GPM)

A

(Sales - cogs) ÷ sales = Gross profit ÷ sales

Used to compare across companies and time

Common size income statement item

41
Q

Review | Factors that cause cash flow changes, impact shareholder value

A
  • Changes in product mis toward lower-margin products
  • New products introduced at low prices to gain market share
  • Increases in production costs
  • Decrease in production volume
  • Increase in supply-chain costs (e.g., procurement, transportation, technology, and insurance.)
  • More generous sales discounts or sales returns policies
  • Inventory obsolescence and/or overstocking
  • Warranty costs
  • General decline in economic activity
  • New competitors in the market
  • Regulation that inhibits sales or adds fees or taxes to products sold
42
Q

What is Inventory Turnover and how is it calculated

A

Measures the number of times during the period that hte company sells its inventory and is computed as follows:

Inventory Turnover = COGS ÷ Average Inventory

Paul said we should use: cogs (IS) ÷ Ending Inventory (BS)

Cogs (IS) / EI (BS)

Also, he noted: always a ratio of an IS item to a BS item

43
Q

Define Average Days Inventory Outstanding

A

DIO measures the days required to sell the average inventory available for sale and it is computed as follows

DIO = 365 ÷ Inventory Turnover = (365 x Average Inventory) ÷ COGS

Note: we calculate average inventory as a simple average fo the balance at the beginning and the balance at the end of the period

44
Q

Review adjusted cogs (53 week year)

A

Common approach is to multiply by 52/53

This gives you a comparable cogs to a 52 week year

45
Q

Name 2 reasons an analysis of days inventory outstanding is important

A
  1. Inventory quality - the ratios can be compared over time and across competitors. Fewer days is favorable
  2. Asset utilization - goal is to optimize inventory investment
46
Q

What 2 alternative explanations for ± DIO must we consider

A
  • Product mix can include more/less higher margin inventories that sell more slowly
  • A company can change its promotion policies
47
Q

What operational Δ’s can companies make to optimize inventory

A
  • Improved manufacturing processes
  • JIT deliveries from suppliers
  • Demand-pull production
48
Q

What 2 margins do we use to analyze accounts payable

and what are their equations?

A
  1. Accounts Payable Turnover (APT)
    * APT = COGS ÷ Average Accounts Payable
  2. Days Payable Outstanding (DPO)
    * DPO = 365/APT = (365 x Average Accounts Payable) ÷ COGS
    * Note: In managing DPO we want to maximize available cash while minimizing supply-chain disruption*
49
Q

Describe the Perpetual System for Tracking Inventory

A

Perpetual - every time there’s a transaction, general ledger T account is adjusted

  • e.g. For a purchase of inventory $1,000
    • Debit inventory 1000
      • Credit cash 1000
  • e.g. Sold inventory for $2,000, cogs $500
    • Debit cash 2000
      • Credit Sales (IS) ​ 2000
    • Debit Cost of sales (IS) 500
      • Credit Inventory ​ 500
    • No EOY adjustments
50
Q

Describe the Periodic System for Tracking Inventory

A

Periodic - only adjust inventory count occasionally, or periodically

  • e.g. purchase of inventory for $1,000: create temporary account called “Purchases”
    • Debit Purchases. 1000
      • Credit Cash. 1000
  • e.g. Inventory sale for $2,000 cash, cogs $500
    • Credit Cash. 2000
      • Debit Sales (IS). 2000
  • e.g. Adjusting Entry
    • Debit Inventory (EI). 700
    • Debit Cost of Sales (IS). 500
      • Credit Purchases. 1000
      • Credit Inventory (BS). 200

Inventory T account stays at BB throughout the year until EOY

Cost of sales is the plug figure. EI = Ending Inventory

51
Q

Describe how to handle Missing Inventory - Perpetual Method

A

Perpetual Method

  • Lost or stolen inventory (IS) 100
    • inventory (BS) 100
52
Q

Describe how to handle Missing Inventory - Periodic Method

A

Periodic Method - As reported

  • Inventory (EI) 700
  • Cost of sales (IS) 500
    • Purchases 1000
    • Inventory (BI) 200

Period Method - As adjusted

  • Inventory 600
  • Cost of Sales 600
    • Purchases 1000
    • Inventory 200
53
Q

Define Working Capital

A

Current Assets less Current Liabilities

54
Q

Recording Inventory - Ledger and T accounts

A

See attachment

55
Q

Where would you find what inventory method is used on a 10-K

A

Check the first footnote

56
Q

What 3 things should you check if LIFO is used

A
  1. What is the size of the LIFO reserve
  2. Did the reserve decrease? (Might reflect a LIFO liquidation. Would reverse the usual differneces b/t LIFO and FIFO, i.e. LIFO net income is higher, LIFO cash flows are lower) Decrease in LIFO reserve results in an increase in income
  3. Adjust for the following ratios (i.e. to a FIFO basis)
    • Inventory Turnover (Cogs / EI)
    • Current Ratio (Current Assets / Current Liabilities)
57
Q

What ratios should you analyze WRT LIFO?

A
  1. Gross margin ratio (sales - cogs) / Sales
    • Increase in ratio implies sales growing faster than costs
  2. Inventory Turnover (cogs / EI)
    • Increase in ratio implies cost of goods sold growing faster than inventory on the BS
58
Q

Name 2 reasons for a LIFO reserve decrease

A
  1. Costs for inventory drop
  2. LIFO liquidation
59
Q

Review LIFO reserve increases and decreases WRT FIFO

A

LIFO reserve increases

  • FIFO Net Income > LIFO Net Income
  • Cash LIFO > Cash FIFO

LIFO reserve decreases

  • LIFO Net Income > FIFO Net Income
  • Cash FIFO > Cash LIFO
60
Q

Describe Inventory Costs on the Financial Statements for LIFO & FIFO

A

FIFO LIFO BS: Inventory Newer Costs Older Costs IS: Cogs Older Costs New Costs

61
Q

Describe impact of rising prices on FIFO & LIFO Net Income, Taxes, and Cash Flows

A

FIFO LIFO Net Income (IS) Higher Lower Taxes Higher Lower Cash Flows Lower Higher

62
Q

Which Statement is Cogs on

A

Income Statement

63
Q

Which statement is Ending Inventory on

A

Balance Sheet

64
Q

Equation for Inventory

A

BI + Purchased Inventory = Cogs + EI

Financial Accounting (10 decks)

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