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Flashcards in FSA: Inventories Deck (16):

COGS equation =

COGS = beginning inventory + purchases - ending inventory



Product costs (capitalized on BS) =

Some Inventory costs are capitalized on the balance sheet, so expense is not recognized until the inventory is sold and revenue is recognized.

Same for IFRS and GAAP: 

Freight in, Raw materials cost, conversion costs.


Product costs (expensed as incurred) =

AKA period costs (expensed in the period incurred)

abnormal waste, freight out, storage cost (not reqd as part of production), administrative overhead, selling costs.


Cost flow methods = 

GAAP allows all: specific identification, average cost, FIFO, LIFO

IFRS does not allow LIFO

FIFO will understate COGS in an inflationary environment, overstating earnings

LIFO will overstate COGS in an inflationary environment, understating earnings (reducing income taxes, increasing cash flows)

Note: During inflationary or deflationary periods, weighted avg method will give a cost between LIFO and FIFO.




Inventory systems: periodic and perpetual =

periodic: inventory and COGS are determined at the end of the period (beginning + purchases = goods available for sale, - ending = inventory).

Inventory acquired during the period is recorded in the purchases account

Perpetual: inventory and COGS are continuously updated. 

FIFO and Spec ID methods: ending inventory and COGS vals are the same for either inventory system

LIFO and Avg Cost: can produce different values


Inventory Reporting: IFRS and GAAP =

AKA carrying value

IFRS: lower of cost or net realizable value

net realizable value is expected sales price - estimated selling and completion costs

GAAP: lower of cost or market, where market is replacement cost (but must be between NRV and NRV minus normal profit margin)

Write down: if NRV/Market is less than cost, the loss is written down on the BS and a loss is recognized on the IS (IFRS and GAAP)

Write up: if NRV increases we recognize a gain on the IS by reducing COGS (..why?) (only IFRS)


Inventory Reporting: An analysts notes =

LIFO reporting typically means reporting a lower value for inventory. This means LIFO companies are less likely to have inventory write downs (compared to FIFO/avg cost)

Inventory writedowns may affect ratios ie. inventory turnover, and affect comparability over periods. 

In certain industries, companies can report inventory above historical cost - producers and dealers of commodity type products - can use market value (producers of agriculture/forest products/metals etc)


Required inventory disclosures =

  • cost flow method used
  • carrying value of inventory, with classification if appropriate (raw materials, finished goods, etc)
  • carrying value of inventories reported at fair value less selling costs
  • cost of inventory recognized as an expense during the period (COGS)
  • inventory writedowns over the period
  • reversals of inventory writedowns (plus circumstances)
  • carrying value of inventories pledged as collateral


Inventory Changes =

firms can change cost flow methods. 

changes are made retrospectively (except change to LIFO) and old statements are recast.

LIFO changes are made prospectively - pre LIFO value of inventory becomes the first layer of new LIFO inventory

IFRS: firm must show the change will provide more reliable/relevant information

GAAP: firm must show why the change is preferable



Effect on ratios: Profitability =

LIFO -> higher COGS, lower earnings. Ratios with COGS will be lower (lower gross, operating, net profit margins compared to FIFO)


Effect on Ratios: Liquidity =

LIFO -> lower inventory value on BS. Lower current assets. Lower current ratio (than FIFO) and working capital (quick ratio is unaffected)


Effect on ratios: Activity =

LIFO -> higher COGS, higher inventory turnover (COGS/average inventory), results in lower days of inventory on hand (365/inventory turnover)


Effect on Ratios: Solvency =

LIFO -> inventory is lower, lower total assets, lower owners' equity (assets - liabilites), higher debt ratio and debt-to-equity ratio

Can also be looked at as: higher COGS, lower inventory, lower income, lower retained earnings/owners' equity



Inventory Turnover & growth =

high turnover together with slower growth may show inadequate inventory quantities (avg inventory is low, as opposed to high COGS being the driver of high turnover)



Gross profit margin =

looks at unit sales price and cost per unit sold.

gross profit margin will be less in industries with high competition.

also a function of product type - typically larger for specialty/luxury goods (these firms will usually have a lower turnover ratio too)