Reading 27- Inventories

Question 1

Distinguish between costs included in inventories and costs recognized as expenses in the period in which they are incurred.

Answer 1

Inventory Costs included in COGS=
*purchase cost for inventory, conversion cost/direct conversion cost, manufacturing costs (transportation costs, packaging costs, storage costs)

Cost Recognized as Expenses= fixed costs (overhead & rental property costs)

Question 2

Describe different inventory valuation methods (cost formulas).

Answer 2

FIFO,LIFO, Weighted Average Costs:

-Of these, there is a major difference between what is acceptable under IFRS and GAAP.

US GAAP- FIFO, Weighted average
IFRS- FIFO,LIFO, Weighted Average

Question 3

Calculate and compare cost of sales, gross profit, and ending inventory using different inventory valuation methods and using perpetual and periodic inventory systems.

Answer 3

There are 2 Inventory Systems: Periodic + Perpetual
-Periodic = COGS is calculated at the end of the period using one of the accounting methods.

• Perpetual = COGS is calculated when an order is placed to sell the goods in the inventory account on time.
• GROSS PROFIT/COST OF SALES= changes when on different inventory systems; different when on different inventory methods.

Question 4

Calculate and explain how inflation and deflation of inventory costs affect the financial statements and ratios of companies that use different inventory valuation methods.

Answer 4

With inflation, what happens is that:

LIFO Method: Last items are less expense because of inflationary affect. Value of the dollar has gone down and the goods are priced higher as well.

COGS INCREASES
END INV DECREASES
GROSS PROFIT MARGIN DECREASES
TAXES DECREASES
CASH ACCOUNTS INCREASE

RATIO EFFECTS-
INVENTORY TURNOVER RATIO INCREASES
CURRENT RATIO DECREASES (BECAUSE COGS IS HIGHER)

Question 5

Explain LIFO reserve and LIFO liquidation and their effects on financial statements and ratios.

Answer 5

LIFO Reserve- when using the LIFO method for inventory management, please be sure to keep a “count on the LIFO reserve.” This LIFO reserve is important because it shows the change in the inventory’s total cost from after LIFO method was applied.

LIFO Liquidation- the number of units sold exceed the number of units in the inventory. This causes an unexpected “HIGHER THAN AVERAGE PROFIT” which can NOT BE PROJECTED INTO THE FUTURE BECAUSE OF THE INFLATION.

so you might have temporary higher profits because you tap into the cheaper inventory that you have

Question 6

Convert a company’s reported financial statements from LIFO to FIFO for purpose of comparison.

Answer 6

So an analyst might be asked to do this to make 2 company reports comparable. This has extra calculations where you have to use the LIFO RESERVE

Question 7

Describe the measurement of inventory at the lower of cost and net realizable value.

Answer 7

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Question 8

Describe implications of valuing inventory at net realizable value for financial statement and ratios.

Answer 8

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Question 9

Describe the financial statement presentation of and disclosures relating to inventories.

Answer 9

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Question 10

Explain issues that analysts should consider when examining a company’s inventory disclosures and other sources of information.

Answer 10

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Question 11

Calculate and compare ratios of companies, including companies that use different inventory methods.

Answer 11

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Question 12

Analyze and compare the financial statements of companies, including companies that use different inventory methods.

Answer 12

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