Vol. 3 LM5 Inventory Management Flashcards
Inventory disclosures
US GAAP vs IFRS
p. 286
- US GAAP do not permit the reversal of prior-year inventory write-downs.
- US GAAP require disclosure of significant estimates applicable to inventories and any material amount of income resulting from a LIFO liquidation
List
inventory management ratios
p. 286
- inventory turnover
- days of inventory on hand
- gross profit margin
describe
inventory turnover ratio
p. 286
measures the number of times during the year a company sells (i.e., turns over) its inventory.
Describe
Days of inventory on hand
p. 286
can be calculated as days in the period divided by inventory turnover
What does it indicate
- high inventory turnover ratio
- low number of days of inventory on hand
p. 286
highly effective inventory management
What does it indicate
- high inventory ratio
- low number of days of inventory on hand
p. 286
could indicate that the company does not carry an adequate amount of inventory or that the company has written down inventory values
What does it indicate
- low inventory turnover ratio
- high number of days of inventory on hand relative to industry norms
p. 286
slow-moving or obsolete inventory
What does it indicate
a significant increase (attributable to increases in unit volume rather than increases in unit cost) in raw materials and/or work-in-progress inventories
p. 287
- may signal that the company expects an increase in demand for its products
- it suggests an anticpated increase in sales and profit
What does it indicate
- substantial increase in finished goods inventories
- raw materials and work-in-progress inventories are declining
p. 287
What are the components of the total cost of inventories?
- all costs of purchase,
- costs of conversion,
- and other costs incurred in bringing the inventories to their present location and condition.
Storage costs of finished inventory and abnormal costs are typically treated as period expenses.
Which inventory valuation methods are allowed under IFRS and US GAAP?
IFRS allows first-in, first-out (FIFO); weighted average cost; and specific identification.
US GAAP allows these methods plus the last-in, first-out (LIFO) method.
How does the choice of inventory valuation method affect financial statements?
- It affects the carrying amounts of inventory and cost of sales,
- impacting current assets, total assets, gross profit, net income, and financial ratios derived from these figures.
What is LIFO liquidation and its impact?
- LIFO liquidation occurs when ending inventory units decline from the beginning of the year.
- If unit costs have risen, this leads to an inventory-related increase in gross profits.
`
P1
inventory cost is least likely to includue:
A. production-related storage costs
B. costs incurred as a result of normal waste of materials
C. transportation costs of shipping inventory to customers
C is correct.
Transportation costs incurred to ship inventory to customers are an
expense and may not be capitalized in inventory. (Transportation costs incurred to bring inventory to the business location can be capitalized in inventory.)
Storage costs required as part of production, as well as costs incurred as a result of normal waste of materials, can be capitalized in inventory. (Costs incurred as a result of abnormal waste must be expensed.)
P11
Cinnamon Corp. started business in 2017 and uses the weighted average cost
method. During 2017, it purchased 45,000 units of inventory at €10 each and sold
40,000 units for €20 each. In 2018, it purchased another 50,000 units at €11 each
and sold 45,000 units for €22 each. Its 2018 cost of sales (€ thousands) was closest
to:
€490
€491
€495
B is correct.
Cinnamon uses the weighted average cost method, so in 2018, 5,000
units of inventory were 2017 units at €10 each and 50,000 were 2008 purchases at €11.
* The weighted average cost of inventory during 2008 was thus (5,000 × 10) + (50,000 × 11) = 50,000 + 550,000 = €600,000, and
* the weighted average cost was approximately €10.91 = €600,000/55,000.
* Cost of sales was €10.91 × 45,000, which is approximately €490,950.