Inventories Flashcards
What is capitalized costs?
They are included in the cost or carrying value of inventories on the BS.
Which items are capitalized costs?
- Cost of purchase: purchase price, import duties, taxes, insurance, and other costs that are directly attributable to the acquisition of finished goods, trade discounts, and other rebates that reduce costs of purchase.
- Cost of conversion: DL and other (fixed and variable) direct overheads.
Which items are expensed in the income statement (not capitalized)?
- Abnormal costs from material wastage
- Abnormal costs of labor or wastage of other production inputs
- Storage costs that are not a part of the normal production process
- Administration expenses
- Selling and marketing costs
Describe the First in, first out (FIFO) method.
- Oldest units purchased or manufactured are the first ones sold.
- Newest units purchased or manufactured remain in ending inventory.
- COGS is composed of units valued at the oldest prices.
- EI is composed of units valued at the most recent prices.
Describe the Last in, first out (LIFO) method.
- Newest units purchased or manufactured are the first ones sold.
- Oldest units purchased or manufactured remain in EI.
- COGS is composed of units valued at the most recent prices.
- EI is composed of units valued at the most recent prices.
Why is FIFO a good method and what happens to LIFO and AVCO when prices are rising, falling, and stable?
FIFO will always give a better reflection of the economic value of inventory.
- Prices are rising: LIFO & AVCO will understate EI value.
- Prices are falling: LIFO & AVCO will overstate EI value.
- Prices are stable: the three methods will value inventory the same.
Why is LIFO a good method and what happens to FIFO and AVCO when prices are rising, falling, and stable?
LIFO will always offer a closer reflection of replacement cost in COGS.
- Prices are rising: FIFO and AVCO will understate COGS.
- Prices are falling: FIFO and AVCO will overstate COGS.
- Prices are stable: the three methods will value inventory the same.
What is the periodic inventory system?
- It is the quantity of inventory on hand calculated periodically
- OI + purchases = Goods available for sale
- Goods available for sale = EI + COGS
What is the perpetual inventory system?
- It is the changes in the inventory account updated continuously.
- Purchases and sales are recorded directly in the inventory account as they occur.
What is the impact on the company value under LIFO?
- It will appear less profitable, less liquid, and more highly leveragedé
- It will have a higher company value as the PV of its expected future cash flows would be higher.
What are the two reasons for a decline in the LIFO reserve? Describe them.
- LIFO liquidation: it occurs when a firm that uses LIFO sells more units during a given period than it purchases over the period.
- Declining prices: It occurs when prices of the firm’s products fall over a given period.
What are the inventory method changes under IFRS?
A change in policy is acceptable only if the change results in the provision of more reliable and relevant information:
- Changes in inventory accounting policy are applied retrospectively
- Information for all periods presented in the financial report is restated
- Adjustments for periods prior to the earliest year presented.
What are the inventory method changes under US GAAP?
Similar to IFRS, but the company:
- Must explain how the adopted inventory accounting method is superior.
- May be required to seek permission from the internal revenue service.
- The changes to the financial statement must be made retrospectively.
What is the measurement of inventory requirements under IFRS?
- Inventory must be stated at the lower cost or net realizable value (NRV)
- Reversals of any write-downs are required
What is the measurement of inventory requirements under US GAAP?
- Requires the application of the cost or LCM
- Reversal of any write-down is prohibited
