Inventories Flashcards
Inventory costs that can be capitalized
ie Inventories on B.S
Cost of purchase (price, import tax, transport and handling)
Cost of conversion (labor, material, overheads, raw mat to finished goods)
Transportation to showroom/final location
Inventory costs that are expensed
ie COGS on I.S Abnormal waste Storage of final/finished goods Admin overhead Selling costs Shipping to customers
Inventory Valuation Methods
Specific Identification
FIFO
Weighted Average Cost
LIFO
Weighted Average Cost formula
= Total cost of units available for sale / total units available for sale
LIFO
- newest items purchased/manuf are sold first
- oldest goods remain in ending inventory
- COGS reflects COGS of purchaed/manuf recently
- value of inventory reflects cost of older goods
- not allowed under IFRS
LIFO during inflation v FIFO
LIFO will have higher COGS and lower NI
COGS formula
= beginning inventory + purchases - ending inventory
Ending inventory formula
= beginning inventory + purchases - COGS
Periodic and perpetual systems COGS and ending inventory will be the same for
Specific identification and FICO
Periodic and perpetual systems COGS and ending inventory will be different for
LIFO and WAC
LIFO v FIFO with rising prices and stable inventory levels. (which is higher or lower)
COGS
LIFO: higher
FIFO: lower
LIFO v FIFO with rising prices and stable inventory levels. (which is higher or lower)
Taxes
LIFO: lower
FIFO: higher
LIFO v FIFO with rising prices and stable inventory levels. (which is higher or lower)
EBT
LIFO: lower
FIFO: higher
LIFO v FIFO with rising prices and stable inventory levels. (which is higher or lower)
NI
LIFO: lower
FIFO: higher
LIFO v FIFO with rising prices and stable inventory levels. (which is higher or lower)
Ending Inventory
LIFO: lower
FIFO: higher
LIFO v FIFO with rising prices and stable inventory levels. (which is higher or lower)
Working capital
LIFO: lower
FIFO: higher
LIFO v FIFO with rising prices and stable inventory levels. (which is higher or lower)
Cash flow (after tax)
LIFO: higher
FIFO: lower
US GAAP firms prefer LIFO because
taxes paid are lower
When prices are increasing, LIFO results in:
higher COGS lower profit lower net income tax lower net income higher after tax cash flow
LIFO Reserve
-definition
The LIFO reserve is the difference between the reported LIFO inventory carrying amount and the inventory amount that would have been reported if FIFO would have been used.
LIFO Reserve
-equation
LIFO Reserve = FIFO inventory value - LIFO inventory value
*LIFO reserve amount must be disclosed
FIFO Inventory value =
Formulas for adjusting inventory
FIFO Inventory = LIFO inventory value + LIFO reserve
FIFO COGS =
Formulas for adjusting inventory
“What amount would ABC’s COGS have been if it had used FIFO instead of LIFO?”
LIFO COGS - (ending LIFO reserve - beginning LIFO reserve)
FIFO NI =
Formulas for adjusting inventory
“What net income would ABC report for yr x if it had used the FIFO method instead of LIFO method”
FIFO NI = LIFO NI + changes in LIFO reserve (1-t)
FIFO retained earnings =
Formulas for adjusting inventory
LIFO retained earnings + LIFO reserve (1-t)
CFO FIFO
Formulas for adjusting LIFO to FIFO
By what amount would net cash flow from operating activities change if ABC used FIFO instead of LIFO?
CFO FIFO = CFO LIFO - impact of the change on income tax paid
Formula:
What is the tax savings that ABC has generated for yr X by using LIFO method instead of FIFO?
Tax savings = change in LIFO reserve * new tax rate + last year LIFO * old tax rate
LIFO liquidation
when the number of units sold in a period exceeds the number of units produced
*can be used to manipulate earnings. warning sign if gross profit increases and LIFO reserve decreases
Consequences of LIFO liquidation:
- COGS does not reflect recent costs during periods of rising prices
- overstates net income
- higher taxable income and higher tax payments
- positive cash flow
Net realizable value
- definition and who’s perspective
NRV is the estimated selling price under ordinary business conditions minus estimated costs needed for sale
from the seller’s perspective
NRV formula
NRV = estimated sales price - estimated selling costs
Market value
- definition and who’s perspective
current replacement cost subject to lower or upper limits
from buyer’s perspective
Market value formula
Market value limits = (NRV - normal profit margin, NRM)
Inventory measurement under GAAP
- measured at the lower of cost or market value
- if cost exceeds market value, inv is written down to market value on BS and loss is recognized
- no revised write-downs
- *commodities and agricultural goods prices can be reported above historical costs
Inventory measurement under IFRS
- measured at cost or net realizable value
- if NRV is less than BS cost, inv is written down to NRV
and loss in IS COGS - inventory can be written up and gain is recogn. on IS
- only written up to loss previously recognized
-*commodities and agricultural goods prices can be reported above historical costs
Inventory write-downs has a ________ effect on profitability, liquidity and solvency rations, but has a _______ effect on activity ratios.
negative effect on profitability, liquidity and solvency rations,
but has a positive effect on activity ratios.
Inventory Turnover ratio
*inflationary environment impact on inventory-related ratios
Numerator: COGS is higher under LIFO
Denominator: Avg inventory is lower under LIFO
Impact on ration: Higher under LIFO
Days of inventory ratio
*inflationary environment impact on inventory-related ratios
Numerator: number of days is the same
Denominator: inventory turn over is higher under LIFO
Impact on ration: lower under LIFO
Total asset turnover ratio
*inflationary environment impact on inventory-related ratios
Numerator: Revenue is the same
Denominator: average total assets is lower under LIFO
Impact on ration: higher under LIFO
Current ratio
*inflationary environment impact on inventory-related ratios
Numerator: Ending inventory is lower under LIFO so CA are lower
Denominator: current liabilities are the same
Impact on ration: lower under LIFO
Cash ratio
*inflationary environment impact on inventory-related ratios
Numerator: cash is higher under LIFO bc taxes are lower
Denominator: CL are the same
Impact on ration: higher under LIFO
Gross profit margin
*inflationary environment impact on inventory-related ratios
Numerator: gross profit is lower under LIFO bc COGS are higher
Denominator: revenue is the same
Impact on ration: lower under LIFO
ROA
*inflationary environment impact on inventory-related ratios
Numerator: NI is lower under LIFO as COGS are higher
Denominator: lower avg total assets under LIFO
Impact on ration: lower under LIFO
Debt to equity
*inflationary environment impact on inventory-related ratios
Numerator: debt is the same
Denominator: lower equity under LIFO bc assets are lower
Impact on ration: higher under LIFO
Which inflationary environment impact on inventory-related ratios are
HIGHER UNDER LIFO
- inventory turnover
- total asset turnover
- cash ratio
- debt to equity
Which inflationary environment impact on inventory-related ratios are
LOWER UNDER LIFO
- days of inventory
- current ratio
- gross profit margin
- ROA
