...Notes in 3 stages, until sold, then IS CGS. 1) Raw Materials: Major resources to be used in manufacturing products. 2) Work-in-Process: Costs of materials, labor & overhead needed to make products. 3) Finished Goods: Completed WIP costs, ready to be sold. Service Co: No Inventory or CGS accounts (of course, many companies are hybrids, > 1 type). 3. Know the CGS Formula used to determine CGS on the IS: + Beginning Inventory (BI: Costs of inventory not sold from last period’s BS) + Purchases (All costs to buy including Transportation-in, less any Purchase Discount accounts) = Cost of Goods available for Sale (CGAS: Total cost that can be sold, split between EI & CGS) – Ending Inventory (EI: Year-end physical count * unit costs based on system & method used) = Cost of Goods Sold (CGS: Cost of inventory sold this period, switch BS asset to 1st IS expense) 4. What is a common way that a Co. overstates NI (“cooks the books”) & what are FS...
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...C H A P T E R 8 VALUATION OF I NVE NTOR I E S : A COST-BASIS APPROAC H LEARNING OBJECTIVES After studying this chapter, you should be able to: •1 •2 •3 •4 •5 •6 •7 •8 •9 •10 Identify major classifications of inventory. Distinguish between perpetual and periodic inventory systems. Identify the effects of inventory errors on the financial statements. Understand the items to include as inventory cost. Describe and compare the cost flow assumptions used to account for inventories. Explain the significance and use of a LIFO reserve. Understand the effect of LIFO liquidations. Explain the dollar-value LIFO method. Identify the major advantages and disadvantages of LIFO. Understand why companies select given inventory methods. Inventories in the Crystal Ball A substantial increase in inventory may be a leading indicator of an upcoming decline in profit margins. Take the auto industry as an example. Detroit’s inventories have been growing for several years because the domestic manufacturers like to run the factories at full capacity, even if they are not selling cars as fast as they can make them. The current arrangement is particularly tough for General Motors. It overproduces and then tries to push the sales with incentives and month-long “blow-out” sales. GM is hoping that the ever-growing market will cover the problem until customer demand grows to the point where the cars are purchased without so many incentives. But recently, all that was growing was GM inventories...
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...significant productivity improvements over Westwood. But these improvements were not reflected in the financial statements (Exhibit 1). Morgan Manufacturing used LIFO as its inventory costing method, while Westwood used FIFO. Additionally, comparison of three key ratios indicated relative differences between these two competitors: gross margin percentage, pre-tax return on sales, and pre-tax return on assets. And calculations of these three ratios are below: Ratio | Calculation | Gross margin percentage | Gross margin/ Sales | Pre-tax return on sales | Income before tax/Sales | Pre-tax return on assets | Income before tax/ Total assets | Based on the two different methods they used to account for inventory, here is the 2006 comparison of the three ratios between Morgan Manufacturing and Westwood: Ratio | Morgan Manufacturing | Westwood, Inc. | Difference | Gross margin percentage | 44.5% | 45% | -0.5% | Pre-tax return on sales | 14.5% | 15% | -0.5% | Pre-tax return on assets | 13.4% | 13.4% | 0 | Since Westwood uses FIFO as its inventory accounting method, conversion of Morgan Manufacturing’s accounts from LIFO to FIFO makes some adjustment so that the comparison could be done on a comparable basis. According to the relationship between Inventory, purchase and COGs, also the definition of LIFO reserve, we can get the equations as...
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.... . . . . . . . . . Cost Flow Assumption FIFO Financial Statements Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . Gross Margin on Sales . . . . . . . . . . . . . . . . . . . . . . . Ending Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . aTV $250 290 300 $840 $550 Weighted Average (2) $550 280b $270 $560e LIFO (3) $550 300c $250 $540f (1) $550 250a $300 $590d set 1 costs $250. TV sets costs $280 ( cTV set 3 costs $300. bAverage dTV $840/3). sets 2 and 3 cost $290 $300 $590. average TV sets cost 2 $280 $560. fTV sets 1 and 2 cost $250 $290 $540. eTwo LAST-IN, FIRST-OUT The last-in, first out (LIFO) cost flow assumption assigns the costs of the latest units acquired to the withdrawals and assigns the costs of the oldest units to the ending inventory. Some theorists argue that LIFO matches current costs to current revenues and, therefore, that LIFO better measures income. Column (3) of Exhibit 7.3 illustrates LIFO. LIFO assumes that the firm sells TV set 3 costing $300 while the costs of TV sets 1 and 2 remain...
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...Learning Team Deliverable Team D The advantages of last-in first-out (LIFO) method consist of four different components. The first advantage of LIFO is recent cost against current revenues. This is advantage because the inventory cost will matched the physical cost of the replacement inventory without inflation to drive up the cost. The LIFO reduced the inventory profits by matching the recent costs against revenues. This will help in eliminating cost of goods sold to be understated and profit to be overstated. The second advantage of LIFO is tax benefits and improvement in cash flows. The advantage of inventory being purchase at the higher cost is matched to the revenues of the period. This will result in the profit being properly stated for tax purpose. This will cause a reduce in the tax bill and result in helping to improve the cash flow of the company. The third advantage of LIFO is minimizing write down inventory to market cost. The advantage of the inventory being purchased would not be affected by future price increase. By using this LIFO method the inventory is usually purchased at the higher price and sold at the higher prices first. The result of using LIFO minimized the need to write down prices due to future price hikes. The fourth advantage of LIFO is physical flow of inventory. The advantage is important in most situations because of the physical inventory received by the company. The company tracks of the inventory that is received last in...
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...8394d_c08.qxd 6/11/02 12:30 PM Page 345 mac62 mac62:1253_GE: Accounting for Inventories Inventories in the Crystal Ball Policy makers, economists, and investors all want to know where the economy is headed. For example, if the economy is headed for a slow-down, it might be prudent on the part of the Federal Reserve to cut interest rates or for Congress to consider a tax cut to head off an economic downturn. Information on inventories is a key input into various decision makers’ economic prediction models. For example, every month the U.S. Commerce Department reports data on inventory levels and sales. As shown in the table below, in a recent month these data indicated an increasing level of inventories. November Inventory and Sales (billions of dollars, seasonally adjusted) Total business inventories Total business sales Inventory/Sales ratio 1999 $1,145 $ 862 1.33 2000 $1,221 $ 896 1.36 Percent Change ϩ6.64% ϩ3.94% More importantly, not only were inventories rising, but they were rising at a faster rate than sales. These data raised some warnings about future economic growth, because rising inventory levels relative to sales indicate that consumers are trimming spending faster than companies can slow production.1 These data also raised warning flags for investors in individual companies. As one analyst remarked, “When inventory grows faster than sales, profits drop.” That is, when companies face slowing sales and growing inventory...
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...about the initiative to wipe out the LIFO inventory technique seems that is not a piece of cake. Actually is so controversial that is putting companies, which are using LIFO in real problems. Some of the reason that companies had been using LIFO is because the benefits of paying less tax and also for book purposes. What I think about the three options of eliminate LIFO either for financial accounting or tax purposes, or not allowing it for financial accounting purposes but allowing it for tax purposes by removing the conformity requirement or allowing it for financial reporting and tax purposes by conforming IFRS to US standards in some way my response is “Eliminate LIFO”. So, Last-in-first-out (LIFO) is an inventory accounting technique which allocates the most recent inventory prices to cost of goods sold and the oldest inventory prices to items remaining in the inventory. In a period of increasing prices, this assumption assigns the recent and higher prices to cost of goods sold and the older lower prices to inventory. LIFO can have a significant cumulative downward effect on the inventory’s value. The cost of goods sold for any particular year equals the sum of beginning inventory, plus purchases, less ending inventory. Thus, a lower ending inventory increases cost of goods sold and reduces taxable income. Under current tax law, companies are allowed to use LIFO for tax purposes only if it also uses LIFO for financial reporting purposes. LIFO inventories means that the last...
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...– Task 4 There are several methods that a company can use to calculate the value of the goods in inventory. By reporting and analyzing such information, a company can help to predict financial performance and the best plan to achieve results. Such inventory valuation methods include: Average Cost Method; FIFO; and LIFO. The inventory valuation methods use two different inventory systems – perpetual and periodic. The perpetual inventory system is used when a company reports the cost of goods sold as those goods are sold throughout the accounting period. The periodic inventory system is used when a company reports the cost of goods sold as a residual at the end of the accounting period. Average Cost Average Cost method is defined as “an inventory plan that prices items in the inventory on the basis of the average cost of all similar goods available during the accounting period.” The benefits of Average Cost include: · Simple to calculate and analyze results · Not subject to income manipulation · Useful when dealing with similar inventory items Average Cost method will result in the gross profit and net income in the middle of the FIFO method and LIFO method results. In cases where the Average Cost method is used, the inventory valuation and cost of goods sold will be have different results if the perpetual or periodic inventory system is used. The “Inventory Template” computed the value of the Periodic Average Cost. The value of the inventory using the Periodic...
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...Chapter 5—Inventory Merchandiser Makes a profit by buying and selling merchandise. A wholesaler is an intermediary that buys goods from manufacturers or other wholesalers and sells them to retailers or other wholesalers. A retailer buys goods from manufacturers or wholesalers and sells directly to consumers Operating cycle for Merchandisers Begins with the purchase of inventory and ends when cash is received from selling the inventory. Manufacturer Makes a profit by buying raw materials and transforming them into finished goods that can be sold. Operating cycle for Manufacturers Begins with the purchase of raw materials and ends when cash is received from selling the finished goods inventory. Net Income for Merchandisers and Manufacturers First gross profit is determined by subtracting cost of goods sold from net sales. Then net income is determined by subtracting other expenses from gross profit. Gross Profit (gross margin) Sales revenue minus cost of goods sold Inventory cost the cost of any asset, including inventory, is the sum of all the costs incurred to bring the asset to its intended use, including delivery and installations costs, insurance and storage costs, sales and excise taxes, and subtracting any discounts or allowances. Three types of Inventory Costs (Managerial Accounting) 1) Direct materials are the materials used to make the product. 2) Direct labor is the cost of paying workers to make the product. 3) Manufacturing...
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...Whether the cup is half-full or half-empty depends on the incentives. • “No one ever said accounting is an exact science” The role of judgment • Timing decisions that affect revenue/expense recognition • Which decision you take depends on the objective Public vs. private accounting • When reporting to the public, a firm must follow GAAP. • In resolving internal disputes this may not always be true. Inventory 7 Overview In today’s class we will cover inventories: • Understanding the Inventory Equation • LIFO and FIFO cost-flow assumptions • LIFO tax conformity rule • Inventory accounting: IFRS vs. GAAP • Disclosures regarding cost flow assumptions 8 Two Main Issues Inventory accounting has two fundamental components: 1) Product Costing Decision: What costs are included in each product's inventory account? (Product costing is discussed in depth in managerial accounting). 2) Cost Flow Decision (LIFO/FIFO): Once costs are in the inventory account (i.e., on the Balance Sheet), when are costs transferred to the Income Statement? 9 Inventory Account Beginning inventory + Additions – Cost of goods sold _________________________ Ending Inventory 10 Coke’s Financial Statements...
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...3217 DECEMBER 9, 2008 WILLIAM E. BRUNS SHARON M. BRUNS SUSAN HARMELING Merrimack Tractors and Mowers, Inc.: LIFO or FIFO? Ricardo “Rick” Martino, president and chief operating officer of Merrimack Tractors and Mowers, Inc., of Nashua, New Hampshire, felt that his job had grown much more complicated during 2007 and 2008. Merrimack was a major regional manufacturer and seller of large commercial grass mowers based on a design developed by his grandfather in the years after World War II. The company’s major competitors were John Deere, The Toro Company, Simplicity, and Husqvarna—much older and larger corporations with extensive lines of lawn care and maintenance equipment. Originally, Merrimack mowers were manufactured and assembled in a workshop and factory in Nashua. However, by 2008 the company was buying all of its tractors and machines, manufactured to its specifications, from a contract manufacturer in China, and it was operating almost exclusively as a machine-and-parts designer and distributor. The company had incorporated in 1980, and an initial public offering was followed by additional offerings of shares over the next decade. By 2008 the company had about 4,000 shareholders, including some mutual funds. About 25% of the outstanding stock was held by members of the Martino family, and shares were traded on NASDAQ. Rick had been elected president after the death of his father late in 1995. Martino’s father had initiated several changes and made decisions that led...
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...INVENTORIES QUESTIONS: 1. Write down the definition of ‘Inventory’ under IAS-2. What physical materials does ‘Inventory’ include? 2. According to IAS-2, what are the components of non-components of Inventory Cost? 3. Distinguish between ‘Perpetual’ and ‘Periodic’ system for recording Inventory? Show proper examples. 4. What are the Cost Flow Formulas/Assumptions allowed in IAS-2 for maintaining Inventory? Show examples. Which one should be used in what situation? 5. Explain LIFO? Why LIFO is not permitted in IAS-2. Do you think repealing LIFO was wise decision of IASB? Discuss with its advantages & disadvantages. 6. What is NRV of an asset? When should company write down its inventories to NRV? Explain write-down processes with illustrations. * Write down the definition of ‘Inventory’ under IAS-2. What physical materials does ‘Inventory’ include? * Paragraph-6 of IAS-2 defines inventories as following- 1. Held for sale in ordinary course of business 2. In the process of production for such sale 3. in the form of materials or supplies to be consumed in the production process or in the rendering of services. This definition implies that 3 types of physical materials are to be included in ‘Inventories’- a) Raw Materials b) Work in process c) Finished Goods * According to IAS-2, what are the components of non-components of Inventory Cost? * Components of Inventory Cost: 1) Cost of Purchase Includes-...
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...Readiness Series The uncertain future of LIFO* The uncertain future of LIFO This paper was authored by Christine Turgeon, a partner; Scott Rabinowitz, a director; Helen Poplock, a director; and Sean Pheils, a senior associate with PricewaterhouseCoopers’ Washington National Tax Services (WNTS) practice. For over 70 years, US taxpayers have been able to value the cost of their inventories using the last-in, first-out inventory method of accounting (LIFO). In general, to use LIFO for federal income tax purposes, taxpayers must also use LIFO for financial reporting purposes (herein referred to as the LIFO conformity requirement). The use of LIFO for financial reporting purposes is not permitted under International Financial Reporting Standards as promulgated by the International Accounting Standards Board (IFRS). As a result, a conversion from US generally accepted accounting principles (GAAP) to IFRS likely will eliminate a taxpayer’s ability to use LIFO for federal income tax purposes. Moreover, the fact that LIFO is not permissible under IFRS has led many policymakers to debate whether LIFO should be permitted for tax purposes, irrespective of IFRS conversion. As a result, Congress and the Obama Administration are considering a repeal of LIFO, while taxpayers and practitioners are defending the merits of LIFO as sound tax policy and are seeking an administrative exception to the LIFO conformity requirement. The transition from LIFO to an alternate inventory method will have...
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...Using information in the financial statements and footnotes respond to the following questions in the spaces provided. You must show the details of your computations to be eligible for partial credit. Answer questions for 2011 only, unless specifically asked to do otherwise. Limit you analysis to ExxonMobile’s crude oil, products and merchandise. Ignore materials and supplies. Assume a 35% tax rate if needed. 1. As of the end of 2011, what is the cumulative amount of the holding gain ExxonMobile has experienced on its inventories accounted for using LIFO? What is the cumulative amount at the end of 2010? Which footnote provided the information to answer this question? (3 points) • In millions of dollars (see table below). • [pic] (1 point each) • Footnote #3 “Miscellaneous Financial Information” (1 point) • The cumulative holding gain is called the ‘aggregate replacement cost’ in the inventory footnote 2. Estimate the replacement cost of ExxonMobile’s crude oil, products and merchandise as at the end of 2011 and 2010. What was their average inventory balance using the reported amounts? What was their average inventory balance using the replacement cost amounts? (6 points – 2 points for each year, 1 point for each avg. inventory) [pic] 3. Starting with ExxonMobile’s reported assets, liabilities and equity show how...
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...their particular location at the time. 3. The cost principle governs the measurement of the ending inventory amount. The ending inventory is determined in units and the cost of each unit is applied to that number. Under the cost principle, the unit cost is the sum of all costs incurred in obtaining one unit of the inventory item in its present state. 4. Goods available for sale is the sum of the beginning inventory and the amount of goods purchased during the period. Cost of goods sold is the amount of goods available for sale less the ending inventory. 5. Beginning inventory is the stock of goods on hand (in inventory) at the start of the accounting period. Ending inventory is the stock of goods on hand (in inventory) at the end of the accounting period. The ending inventory of one period automatically becomes the beginning inventory...
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