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CFA Level II Financial Reporting and Analysis > Reading 17 - Inventories > Flashcards

Reading 17 - Inventories Flashcards

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1
Q

What is the formula to determine COGS ?

A

= beginning inventory + purchases -ending inventory

***COGS and ending inventory are inversely related

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2
Q

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

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

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

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

Describe the specific identification method of allocating inventory cost?

A

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

**Is appropriate when inventory items are not interchangeable

****ex. jewelry and automobiles

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5
Q

Describe the FIFO method of allocating inventory cost?

A

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

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6
Q

Describe the LIFO method of allocating inventory cost?

A

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

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7
Q

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

A

FIFO

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8
Q

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

A

LIFO

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9
Q

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

A

LIFO

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10
Q

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

A

FIFO

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11
Q

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

A
  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
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12
Q

What is the LIFO Reserve?

A

a needed adjustment to make LIFO data = to FIFO data

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13
Q

How do you calculate the LIFO reserve?

A

LIFO reserve = FIFO inventory - LIFO inventory

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14
Q

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?

A

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

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15
Q

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:

A
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16
Q

How is the current ratio calculated?

A
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17
Q

How is the inventory turnover ratio calculated ?

A
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18
Q

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

A
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19
Q

How is the gross profit margin calculated ?

A
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20
Q

How is the net profit margin calculated?

A
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21
Q

How is the Return on Assets calculated?

A

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

22
Q

What is a LIFO Liquidation?

A

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

23
Q

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

A
  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)
24
Q

What is the inventory valuation method?

A

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

25
Q

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

A

At the lower of cost or net realizable value

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)

26
Q

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

A

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

27
Q

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

A

IFRS -> Yes

GAAP -> No

28
Q

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 ?

A

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

29
Q

Who results in a higher COGS, FIFO or LIFO ?

A

LIFO

30
Q

Who pays higher taxes, FIFO or LIFO ?

A

FIFO

31
Q

Who has higher Net Income, FIFO or LIFO ?

A

FIFO

32
Q

Who has higher inventory balances, LIFO or FIFO?

A

FIFO

33
Q

What is Working Capital?

A

Current Assets - Current Liabilities

34
Q

Who has higher working capital, LIFO or FIFO?

A

FIFO

35
Q

Who has higher cash flows, LIFO or FIFO?

A

LIFO

b/c less taxes are paid out

36
Q

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

A

FIFO

37
Q

Who has a higher current ratio, LIFO or FIFO?

A

FIFO

38
Q

Who has higher inventory turnover, LIFO or FIFO?

A

LIFO

39
Q

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

A

LIFO

40
Q

Who has higher profitability, LIFO or FIFO?

A

FIFO

b/c LIFOs COGS are higher

41
Q

Who has higher liquidity, LIFO or FIFO?

A

FIFO

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

42
Q

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

A

LIFO

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

43
Q

Who has greater solvency , LIFO or FIFO?

A

LIFO

44
Q

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?

A

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.

45
Q

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

A

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

46
Q

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)?

A

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.
EIFIFO = $100,000 + $30,000 = $130,000

47
Q

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?

A

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

48
Q

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?

A

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.

49
Q

In general, what does the LIFO reserve measure?

A

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

50
Q

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

A
51
Q

How do you calculate Net Income under FIFO when given LIFO data?

A

Net IncomeFIFO = Net IncomeLIFO + LIFO Reserve - LIFO Reserve(Tax Rate)

CFA Level II Financial Reporting and Analysis (7 decks)

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