Week 5 - Balance Sheet Analysis

Question 1

how to calculate gross profit

Answer 1

= sales - COGS

Question 2

what is FIFO

Answer 2

The FIFO inventory costing method transfers costs from
inventory in the order that they were initially recorded

Question 3

What is LIFO

Answer 3

The LIFO inventory costing method transfers the most
recent inventory costs from the balance sheet to COGS

Question 4

which inventory method has the lowest COGS in times of rising prices?

Answer 4

FIFO

In periods of rising costs, LIFO inventories can be markedly lower
than under FIFO
LIFO balance sheets do not accurately represent the cost that a
company would incur to replace its current inventory.

Question 5

what is a LIFO reserve

Answer 5

the difference between FIFO and LIFO

Question 6

why is LIFO prohibited under IFRS

Answer 6

• lack of faithful representation in inventory value
• distortion of financial results
• inconsistent with economic reality (flow of goods)
• non-comparability

Question 7

What is the lower of cost / market rule

Answer 7

if the market value of
inventory is less than its cost, “write down” the inventory to its
market value.

Question 8

How do you write down inventory?

Answer 8

DR. COGS
CR. Inventory

Question 9

How do you Calculate FIFO inventory from LIFO inventory using the LIFO reserve

Answer 9

FIFO = LIFO + reserve

Question 10

what adjustments to the balance sheet are needed to convert LIFO to FIFO

Answer 10

1. increase inventory by RESERVE
2. increase tax liabilities by TAX RATE * RESERVE
3. increase Retained Earnings by DIFFERENCE

Question 11

what adjustments to the income statement are needed to convert LIFO into FIFO

Answer 11

1. decrease COGS by INCREASE IN RESERVE
2. Increase tax expense by INCREASE IN RESERVE * TAX RATE
3. Increase Net Income by DIFFERENCE

Question 12

what is a LIFO liquidation

Answer 12

older inventory is sold (which costs less than new inventory)

the COGS from selling older inventory < cost to get new inventory

*assuming an inflationary environment

Question 13

how do you calculate Asset Turnover

Answer 13

= sales / average assets

Question 14

how do you calculate DIO

Answer 14

Days Inventory Outstanding - number of days to sell inventory

= 365 * (average inventory / COGS)

or

= 365 / Inventory turnover
Inventory turnover = COGS / Avg Inventory

• Inventory turnover - number of times you can sell inventory in a period

Question 15

how do you calculate DSO

Answer 15

Days Sales Outstanding - average length of time payables are deferred

= 365 * (avg AR / sales)

or

= 365 / AR turnover
AR turnover = sales / avg AR

*AR turnover - number of payment cycles per period

Question 16

how do you calculate DPO

Answer 16

days payable outstanding

= 365 * (Avg AP / COGS)

or

=365 / AP turnover
AP turnover = COGS / Avg AP

Note: instead of COGS you could use purchases
purchases = Ending Inventory - beginning inventory + COGS

Question 17

why is DIO important

Answer 17

1. inventory quality
   - product mix of inventories that sell fast or slow
   - change promotion policies
   - improve manufacturing efficiency
2. asset utilization
   - improve manufacturing
   - Just in Time deliveries of raw materials
   - demand pull production

• lower DIO is preferable

Question 18

how do you calculate Cash Conversion Cycle

Answer 18

= DIO + DSO - DPO

• prefer smaller CCC