LM 5: Analysis of Inventories

Question 1

What is inventory?

Answer 1

costs that a company incurs to acquire inputs and prepare them for final sale

Question 2

When are inventory costs recognized on the income statement?

Answer 2

recorded once sold due to the matching principal

Question 3

What is the specific identification inventory method?

Answer 3

keeping track of each specific item in inventory and assigning costs individually instead of grouping items together

Question 4

What is the first in, first out inventory method?

Answer 4

the FIFO inventory valuation method assumes the oldest goods are sold first

Question 5

What is the last in, last out inventory method?

Answer 5

the most recently acquired items are sold first and the oldest items remain in inventory.

Question 6

Where is inventory initially recorded if the item hasn’t been sold?

Answer 6

initially recorded on balance sheet at the cost paid to acquire them

Question 7

If inventory can no longer be recovered due to various factors, what are 2 ways inventories must be carried at lower of under IFRS?

Answer 7

1. Cost
2. Net realizable value

Question 8

What is the formula for net realizable value?

Answer 8

Estimated seeking price - estimated costs necessary to make sale - estimated costs to get inventory ready for sale

Question 9

If inventory can no longer be recovered due to various factors, what are 2 ways inventories must be carried at lower of under UG GAAP?

Answer 9

1. Cost
2. Market Value

Question 10

Under IFRS and US GAAP, what value do commodity producers or traders report?

Answer 10

report at net realizable value

Question 11

Which accounting standard allows inventory write-downs?

Answer 11

both IFRS and US GAAP

Question 12

Which accounting standard allows reversals of write-downs if inventory rises back above the carry amount?

Answer 12

IFRS allows reversals

US GAAP doesn’t not allow reversals of write-downs.

Question 13

What is inventory write-down?

Answer 13

when inventory value declines below its carrying value

Question 14

When must inventory write-downs be recorded?

Answer 14

recorded on the income statement for the period when the assessment is made

Question 15

Which 4 inventory methods are allowed under US GAAP?

Answer 15

1. Specific identification
2. First in, first out (FIFO)
3. Last in, first out (LIFO)
4. Weighted average cost

Question 16

Which 3 inventory methods are allowed under IFRS?

Answer 16

1. Specific identification
2. First in, first out (FIFO)
3. Weighted average cost

Question 17

What is the weighted average cost inventory method?

Answer 17

calculates the average cost of your inventory, per unit.

Question 18

Whats the difference between periodic and perpetual inventory systems?

Answer 18

1. period system, values COGS and ending inventory at end of account period (periodic inventory system uses an occasional physical count to measure the level of inventory and the cost of goods sold.)
2. perpetual system, purchase and sales recorded directly in inventory as they occur. (perpetual system keeps track of inventory balances continuously, with updates made automatically whenever a product is received or sold)

Question 19

If you use LIFO what happens to COGS and ending inventory?

Answer 19

using LIFO will increase COGS and lower ending inventory

Question 20

In a rising environment, how does using LIFO vs FIFO or Weighted average affect COGS, PROFIT, & income tax expense on the income statement?

Answer 20

using LIFO will result in higher COGS, lower profit, and lower income tax expense on the income statement

Question 21

In a rising environment, how does using LIFO vs FIFO or Weighted average affect inventory, assets, & equity on the balance sheet?

Answer 21

using LIFO will result in lower inventory, lower assets, and lower equity on the balance sheet

Question 22

In a rising environment, how does using LIFO vs FIFO or Weighted average affect taxes and operating cash flow on the cash flow statement?

Answer 22

using LIFO will result in lower taxes and higher operating cash flow on the cash flow statement

Question 23

What is LIFO reserve?

Answer 23

an accounting term that measures the difference between the first in, first out (FIFO) and last in, first out (LIFO) cost of inventory for bookkeeping purposes

inventory that would be reported if FIFO method was used

Question 24

How do you calculate LIFO reserve?

Answer 24

LIFO reserve = FIFO inventory value - LIFO inventory value

Question 25

When can companies change inventory methods?

Answer 25

If change makes financial statements more reliable and relevant

Question 26

What is LIFO liquidation?

Answer 26

sells more inventory than it purchases or produces in a given period. This results in the company ‘digging into’ its older LIFO layers of inventory

Question 27

Under IFRS what changes in valuation method require a retrospective restatement?

Answer 27

All, FIFO weighted average, specific identification

Question 28

Under US GAAP what changes in valuation method require a retrospective restatement and which ones don’t?

Answer 28

LIFO to other valuation methods Requires retrospective restatement

Other to LIFO doesn’t require retrospective restatement

Question 29

What is the inventory turnover formula for inventory?

Answer 29

COGS / average inventory

Question 30

What is the gross profit margin formula given sales?

Answer 30

gross profit margin = (Sales - COGS) /sales

Question 31

How much are inventory reversals from prior periods limited to?

Answer 31

limited to the amount of the original write-down