Reading 17 - Inventories

Question 1

What is the formula to determine COGS ?

Answer 1

= beginning inventory + purchases -ending inventory

***COGS and ending inventory are inversely related

Question 2

Under IFRS, what are the permissible methods to allocate inventory cost?

Answer 2

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

Question 3

Under GAAP, what are the permissible methods to allocate inventory cost?

Answer 3

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

Question 4

Describe the specific identification method of allocating inventory cost?

Answer 4

Each units sold is matched with the unit’s actual cost

**Is appropriate when inventory items are not interchangeable

****ex. jewelry and automobiles

Question 5

Describe the FIFO method of allocating inventory cost?

Answer 5

The first item purchased is the first item sold

Adv:

ending inventory is based on most recent purchases, which is the best approximation of current cost

Dis:

COGS is based on the earliest purchase cost. COGS will be understated and earnings will be overstated

Question 6

Describe the LIFO method of allocating inventory cost?

Answer 6

the item purchased most recently is assumed to be the first item sold

Facts:

COGS will be higher than FIFO COGS and earnings will be lower

Lower earnings translate into lower income taxes

Question 7

In an inflationary economic environment, does FIFO or LIFO have a higher ending inventory balace?

Answer 7

FIFO

Question 8

In an inflationary economic environment, does FIFO or LIFO have a higher COGS ?

Answer 8

LIFO

Question 9

In an deflationary economic environment, does FIFO or LIFO have a higher ending inventory balance?

Answer 9

LIFO

Question 10

In a deflationary economic environment, does FIFO or LIFO have a higher COGS?

Answer 10

FIFO

Question 11

What are the two ways firms account for changes in inventory?

Answer 11

1. Periodic System - inventory values and COGS are determined at the end of the accounting period
2. Perpetual System - inventory values and COGS are updated continuously

Question 12

What is the LIFO Reserve?

Answer 12

a needed adjustment to make LIFO data = to FIFO data

Question 13

How do you calculate the LIFO reserve?

Answer 13

LIFO reserve = FIFO inventory - LIFO inventory

Question 14

If a LIFO reserve is calculated when converting figures to FIFO, you also need to calcuate a FIFO COGS.

What is the equation to do this?

Answer 14

FIFO COGS = LIFO COGS - (ending LIFO reserve - beginning LIFO reserve)

Question 15

Dick’s Sporting Goods, which used LIFO, reported end of yr inventory balances of $500 in 2005 and $700 in 2006. The LIFO reserve was $200 for 2005 and $300 for 2006. COGS during 2006 was $3,000.

Convert the 2006 ending inventory and COGS to FIFO basis:

Answer 15

Question 16

How is the current ratio calculated?

Answer 16

Question 17

How is the inventory turnover ratio calculated ?

Answer 17

Question 18

How is the long-term debt to equity ratio calculated?

Answer 18

Question 19

How is the gross profit margin calculated ?

Answer 19

Question 20

How is the net profit margin calculated?

Answer 20

Question 21

How is the Return on Assets calculated?

Answer 21

Avg assets is equal to the Total Assets summed together for the previous 2 years, then divided by 2

Question 22

What is a LIFO Liquidation?

Answer 22

occurs when a LIFO firm’s inventory quantities are declining

The older, lower costs are now included in COGS

The result is higher profit margins and higher income taxes

Question 23

What are the 5 steps that must be done when converting a firm’s F/S from LIFO to FIFO?

Answer 23

1. Subtract taxes on LIFO reserve from Cash Amount (BS)
2. Add LIFO reserve to Inventories Amount (BS)
3. Add LIFO reserve net of tax to Retaining Earnings (BS)
4. Subtract change in LIFO reserve (end - beg) from COGS (IS)
5. Add taxes on change in the reserve to Taxes (IS)

Question 24

What is the inventory valuation method?

Answer 24

Is used in determining the carrying value on the balance sheet and in testing for impairment

Question 25

**Under IFRS**, how is inventory report on the balance sheet?

Answer 25

**At the lower** of cost or net realizable value ## Footnote **_Net Realizable Value_** - is equal to the estimated sales price less the estimated selling costs and completion costs If net relizable values is less than the balance sheet cost, the inventory is "written down" and a loss is taken on the income statement \*\*recovery of the asset can occuer when the inventory can be "written up" and a gain recognized on the income statement ( limited to the amount of the previous loss)

Question 26

Under **GAAP**, how is inventory report on the balance sheet?

Answer 26

Inventory is reported on the balance sheet at the lower of cost or market Market - equal to the replacement cost, cannot be greater than NRV or less than NRV minus a normal profit

Question 27

Can inventory that was "written down" be "written up" if there is a subsequent recovery in the value under GAAP or IFRS

Answer 27

IFRS -\> Yes GAAP -\> No

Question 28

Zoom, Inc sells digital cameras. Per- unit cost information pertaining to Zoom's inventory is as follows: What are the per-unit carrying values for its inventory **_under IFRS_** ?

Answer 28

Remember, under IFRS, inventory is reported on the balance sheet at the lower of cost or net realizable value. Cost = $210 NRV = ($225-22 = $203) So inventory is written down to 203 and a $7 loss is reported on the income statement

Question 29

Who results in a higher **COGS**, FIFO or LIFO ?

Answer 29

LIFO

Question 30

Who pays higher taxes, FIFO or LIFO ?

Answer 30

FIFO

Question 31

Who has higher **Net Income**, FIFO or LIFO ?

Answer 31

FIFO

Question 32

Who has higher **inventory balances**, LIFO or FIFO?

Answer 32

FIFO

Question 33

What is **_Working Capital_**?

Answer 33

Current Assets - Current Liabilities

Question 34

Who has higher **working capital**, LIFO or FIFO?

Answer 34

FIFO

Question 35

Who has higher **cash flows**, LIFO or FIFO?

Answer 35

LIFO b/c less taxes are paid out

Question 36

Who has higher **net & gross margins**, LIFO or FIFO?

Answer 36

FIFO

Question 37

Who has a higher **current ratio**, LIFO or FIFO?

Answer 37

FIFO

Question 38

Who has higher **inventory turnover**, LIFO or FIFO?

Answer 38

LIFO

Question 39

Who has a higher **debt-to-equity ratio**, LIFO or FIFO?

Answer 39

LIFO

Question 40

Who has higher **profitability**, LIFO or FIFO?

Answer 40

FIFO b/c LIFOs COGS are higher

Question 41

Who has higher **liquidity**, LIFO or FIFO?

Answer 41

FIFO b/c LIFO has lower inventory values which are part of many liquidity ratio like the **current ratio**

Question 42

Who has higher **Activity (ie invetory turnover)**, LIFO or FIFO?

Answer 42

LIFO b/c under LIFO COGS is values a more recent, higher costs

Question 43

Who has greater **solvency** , LIFO or FIFO?

Answer 43

LIFO

Question 44

The Baker Company uses the last in, first out (LIFO) inventory valuation method and reported its inventory at $200,000 and its cost of goods sold (COGS) at $500,000. The company’s LIFO reserve increased from $5,000 to $30,000 during the year. What amounts would the company report for ending inventory and cost of goods sold if it were to use the first in, first out (FIFO) method?

Answer 44

Ending inventory under FIFO is equal to LIFO ending inventory + LIFO reserve = 200,000 + 30,000 = 230,000 COGS under FIFO equals LIFO COGS − (ending LIFO reserve − beginning LIFO reserve) = 500,000 − (30,000 − 5,000) = 475,000.

Question 45

Given the following data and assuming a periodic inventory system, what is the ending inventory using the average cost method? _Purchases__Sales_ 40 units at $60/unit 25 units at $65/unit 50 units at $55/unit 30 units at $60/unit 60 units at $45/unit 40 units at $50/unit

Answer 45

Average cost per unit purchased: 40 units at $60/per unit = $2,400 50 units at $55/per unit = $2,750 60 units at $45/per unit = $2,700 Total = 150 units = $7,850 Average cost per unit = $7,850 /150 units = $52.33/unit Purchased 40 + 50 + 60 = 150 units. Sold 25 + 30 + 40 = 95 Ending inventory = 150 − 95 = 55 units × $52.33/unit = $2,878

Question 46

A firm uses the last in, first out (LIFO) accounting method and posts $100,000 as ending inventory. Last year's financial statements show inventory at $110,000. This period's income statement shows costs of goods sold at $90,000 with a LIFO reserve of $30,000. How much inventory was purchased this period, and what would the ending inventory balance be under first in, first out (FIFO)?

Answer 46

EI = BI + P - COGS 100 = 110 + P - 90 P = $80,000 In order to convert ending inventory under FIFO to LIFO you have to add the LIFO reserve to the ending inventory under LIFO. EI_FIFO = $100,000 + $30,000 = $130,000

Question 47

If a firm has a first in, first out (FIFO) inventory of 9,000 and a last in, first out (LIFO) inventory of 6,500, what is the value of the LIFO reserve assuming a 40% tax rate?

Answer 47

LIFO reserve = FIFO inventory − LIFO inventory = 9,000 − 6,500 = 2,500

Question 48

A firm ended the last period with inventory of $4.0 million and a last in, first out (LIFO) reserve of $175,000. During the year, it made purchases of $2.0 million and reported sales of $5.5 million with a gross margin of 0.32. At the end of the year, it reported a LIFO reserve of $75,000. What is the value of the firm’s cost of goods sold (COGS) on a first in, first out (FIFO) basis?

Answer 48

With sales of $5.5 million and a gross margin of 0.32, the COGS (on a LIFO basis) is $3.74 million. In order to convert COGS to a FIFO basis, we need to subtract the change in LIFO reserve during the year: $3,740,000 − ($75,000 − $175,000) = $3,840,000.

Question 49

In general, what does the LIFO reserve measure?

Answer 49

LIFO reserve measures the accumulation of taxes not paid and profits not recognized.

Question 50

How do you calculate the Current Ratio assuming the corporation is now using FIFO when previously they had been using LIFO??

Answer 50

Question 51

How do you _calculate Net Income under FIFO_ when given LIFO data?

Answer 51

Net Income_FIFO = Net Income_LIFO + LIFO Reserve - LIFO Reserve(Tax Rate)