F2 - 2.3 Inventory Flashcards
Under the US GAAP, if the LIFO or retail inventory method is used, then inventory is valued at lower of cost or ….?
Market Value (LCM)
Under the US GAAP, if OTHER THAN the LIFO or retail inventory method is used, then inventory is valued at lower of cost or ….?
NRV (LCNRV)
In the rising prices economy, which inventory costing method produces a lower inventory turnover ratio? Why?
- Inventory turnover ratio = COGS/Average inventory.
- In an inflationary or rising prices economy, COGS reported using FIFO is low, leading to higher net profits.
- Inventory would be higher since it is reported at current prices.
- Therefore, higher Inventories and lower COGS will result in a lower inventory turnover ratio.
- In turnover ratios, turn-it-over to the denominator. So, higher inventory and lower COGS would lead to lower inventory ratio.
How should Write-off of obsolete inventory be treated while calculating COGS?
It should be Deducted while calculating COGS
Cost of goods sold = Opening inventory + Purchases - Write-off of obsolete inventory - Closing inventory
Which inventory costing method will give lowest ending inventory in rising prices economy? Why?
The dollar value LIFO will give the lowest ending inventory when its product lines are subject to specific price increases. This is because LIFO methods operate under the assumption that the last item of inventory purchased is the first one to be sold. Thus, in the case of rising prices, the cost of the most recently acquired inventory will always be higher than the cost of earlier purchases, so the ending inventory balance will be valued at earlier costs which are lower, while the most recent costs appear in the cost of goods sold.
Specific identification, weighted average or FIFO periodic methods would not give a lower inventory value than dollar value LIFO method.
Explain the two types of FOB
The two main types of FOB are:
FOB Origin/Shipping point: The buyer takes responsibility for the goods as soon as they leave the seller’s location. The buyer bears the costs and risks associated with transportation from that point forward.
FOB Destination: The seller retains responsibility for the goods until they reach the buyer’s destination. The seller bears the costs and risks associated with transportation up to that point.
Which inventory costing method will give highest taxable income in rising prices economy? Why?
Under the FIFO method, the goods that arrive first are assumed to be used first. The cost of goods sold would comprise of the cost of units acquired earlier in the year. In a period of rising prices, the cost of goods acquired earlier in the year would be lesser than the cost of goods acquired later. The cost of goods sold would comprise of goods that cost lesser. When cost of goods sold are less, the net profits would be high leading to a high taxable income.
Which inventory costing method will give lesser taxable income in rising prices economy? Why?
Under the LIFO method, the goods that arrive last are assumed to be used first. In a period of rising prices, the cost of goods sold would comprise of the last arrived goods which would be of a higher price, thereby increasing cost of goods sold. This would lead to a lesser net income and a taxable income.
Explain the Basic Concept of FIFO method and its impact on various componants of Financial St.
Under the FIFO method, the goods that arrive first are assumed to be used first.
It means the closing inventory would comprise of the cost of units acquired later in the year, which would be close to the market value of the inventories as these would have been purchased close to the end of the year generally at a higher rate.
This reduces the amount of inventory that would otherwise have been charged to the cost of goods sold during the period. Hence reports Lower COGS as the cost of goods sold would comprise of the cost of units acquired earlier in the year generally at a lower rate.
Reports Lower COGS –> Higher Profits –> Higher Income –> Higher Retained Earnings –> Increase in Capital
Higher Closing Inventory Value –> Higher Current Asset
Higher Profits –> Higher Taxes
US GAAP Valuation –> Lower of the cost or Net Realizable Value (LCNRV)
Explain the Basic Concept of LIFO method and its impact on various componants of Financial St.
Under the LIFO method, the goods that arrive last are assumed to be used first.
It means the closing inventory would comprise of the cost of units acquired earlier in the year, which would NOT be close to the market value of the inventories as these would have been purchased earlier in the year generally at a lower rate.
Accordingly, Under LIFO method COGS reported are the most recent purchases at higher prices which results in lower net profits and lowers income taxes.
Reports Higher COGS (due to most recent purchases at higher price) –> Lower Profits –> Lower Income –> Lower Retained Earnings –> Less Increase in Capital
Lower Closing Inventory Value –> Lower Current Asset
Lower Profits –> Lower Taxes
US GAAP Valuation –> Lower of the cost or Market (LCM)
What is the formule for Inventory Turnover Ratio?
Inventory turnover ratio =COGS / Average inventory
