Flashcards in Inventories,Long Lived Assets Study Session #8 Deck (53):
Determine COGS, Beginning Inventory, Purchases, Ending Inventory
COGS = Begininning Inventory + purchases - ending inventory
Product Costs vs Period Costs
Product Costs are capitalized as inventory and include the purchase cost, conversion costs including related overhead
Period Costs are expensed in the period incurred and include abnormal waste of materials/labour/related overhead, storage costs (Unless required as part of production), admin overhead and selling costs.
Inventory Valuation Methods
FIFO, LIFO, Weighted Avg. Cost.
All under GAPP, LIFO not allowed under IFRS.
Periodic vs Perpetual Inventory system
For periodic COGs and inventory values are determined at end of period.
For perpetual COGS and inventory or updated continuously.
Under FIFO and Specific Identification, COGS and Ending inventory are the same under periodic and perpetual
Under LIFO and WAC, COGS and Ending Inventory are different.
Effects of increasing prices on FIFO/LIFO
LIFO Inventory < FIFO Inventory
LIFO COGS > FIFO COGS
LIFO Net income < FIFO Net income
LIFO tax < FIFO tax
The amount by which LIFO inventory is less than FIFO inventory. Must be reported by companies that use LIFO.
To adjust LIFO to FIFO
1) add LIFO reserve to LIFO inventory
2) increase retained earnings by the LIFO reserve.
Convert COGS LIFO to FIFO
FIFO COGS = LIFO COGS - (Ending LIFO reserve - beginning LIFO reserve)
Occurs when a LIFO firm's inventories decline in a period.
In a period of rising prices, this drawdown in inventory reduces COGS because the lower cost of previously produced inventory is used, resulting in an unsustainable increase in gross profit margin.
Lower of Cost or Net Realizable Value (IFRS)
Lower of Cost or Market Value(GAAP)
is equal to the expected sales price less the estimated selling costs and completion costs. If net realizable value is lower than balance sheet value for inventory, then a write down occurs.
Market Value has an upper limit of net realizable value (Selling price minus selling costs) and a lower limit which is net realizable value minus a normal profit margin.
Write downs occur under GAAP and IFRS. Write ups are not allowed under GAAP.
Required Inventory disclosures in footnotes (same for GAAP and IFRS)
1)Cost flow method used
2)Carrying value of inventory by raw materials WIP and finished goods
3)Carrying value of inventories reported at fair value less selling costs
4)Amount of write downs during the period
5)Reversals to an write downs in the period
6)Carrying value of inventories pledged as collateral
FIFO Characteristics when prices are rising
Higher Ending Inventory
Opposites for falling prices
LIFO Characteristics when prices are rising
Lower Ending Inventory
Opposites for falling prices
Convert LIFO to FIFO
Inventory (FIFO) = Inventory (LIFO) + LIFO Reserve
COGS (FIFO) = COGS (LIFO) - Increase in LIFO Reserve
NI (FIFO) = NI (LIFO) + Increase in LIFO Reserve x (1-tax rate)
RE (FIFO)= RE (LIFO) + LIFO Reserve x (1-tax rate)
High Inventory Turnover w/ Low Sales growth results in...
potentially losing sales by not carrying enough inventory
Capitalized vs expensing
Can capitalize cost as an asset on the balance sheet, or expense a cost through the income statement.
Capitalizing typically occurs with assets that are expecting to provide economic benefit over multiple periods.
Capitalizing lowers income variability and increases near term profits, assets and equity. The opposite occurs with expensing.
R&D (IFRS vs GAAP)
IFRS -Research costs are expensed as incurred, though development costs may be capitalized. Research costs are aimed at discovering new knowledge, development costs are aimed at translating that research into a product.
GAAP- Research & Development are expenseds as incurred. However specific to software, treatment is similar to IFRS.
Acquisition method intangible assets
purchase price allocated to assets/liabilities, any excess value above the purchase price is recorded as goodwill.
Intangible assets are either identifiable or unidentifiable
Under IFRS identifiable intangible assets must be:
1)capable of being separated from the firm or arise from a contractual or legal right.
2)Controlled by the firm
3)Expected to provide future economic benefit.
unidentifiable intangible asset cannot be purchased separately and may have indefinite life. Ie, goodwill.
Carrying (book) value vs historical cost
carrying value is the net value of an asset or liability on the balance sheet.
Historical cost is the original purchase price of the asset including initial installation and transportation.
Straight line depreciation
=original cost -salvage value/depreciable life
Double-declining balance method
=[2/depreciable life in years]/book value at beginning of year x
Units of production method
=[(original cost-salvage value)/life in output units] x output units in the period
Component depreciation (Mainly IFRS)
IFRS requires firms to depreciate component of assets separately. Under component depreciation, the useful life of each component is estimated and depreciation expense is computed separately for each.
Component depreciation is permitted under GAAP but seldom used.
Revaluation Model (IFRS)
permits long-lived asset to be reported at fair value, as long as an active market exists for the asset so fair value can be reliably estimated.
The asset is carried at its depreciated cost, but at each revaluation date is adjusted to its fair value.
Must assess annually. Impaired when carrying value exceeds the recoverable amount.
Recoverable amount is the greater of fair value less selling costs and its value in use.
Value in use is present value of future cash flow stream.
Impairments can be reversed up to the amount they were previously impaired.
Tested only when events/circumstances indicate the firm may not be able to recover the carrying value.
Step 1 - Recoverability Test (if impairment then step 2 is to determine the amount of the loss)
Asset is impaired if the carrying value is greater than the assets future un-discounted cash flow stream.
Step 2 - Loss Measurement
Written down to fair value or the discounted value of future cash flows is the fair value is not known.
Reversal of impairments is not permitted
Intangible assets with indefinite lives
are not amortized, but are tested annually for impairment.
De-recognition of long lived assets
When sold, exchanged or abandoned the asset is de-recognized. The difference between sale proceeds and carrying value is report as a gain/loss on the income statement.
Disclosures for long lived assets (IFRS)
-Basis for measurement
-Useful lives or depreciation rate
-Gross carrying value and accumulated depreciation
-Reconciliations of carrying amounts
-Title restrictions and assets pledged as collateral
-Agreements to acquire PP&E in the future
-Amount of disposals
If revaluation is used:
-how fair value was determined
-carrying value using historical cost model
For intangible assets:
-amount of impairment losses/reversals by asset class
-where losses/reversals show in the income statement
-reason for the impairment loss or reversal
Disclosures for long lived assets (GAAP)
-depreciation expense by period
-balance of major classes of assets
-general description and depreciation methods used
Same as a PPE firm and must provide an estimate of amortization expense for the next 5 years.
-description of the impaired asset
-cause of the impairment
-how fair value was determined
-amount of loss
-where loss is recognized in the income statement
=accumulated depreciation/annual depreciation expense
Total useful life
=historical cost/annual depreciation expense
Remaining useful life
=ending net PPE/annual depreciation expense
IFRS- classified as property owned for the purpose of collecting rental income or earning capital appreciation. Firms have choice of cost model or fair value model when valuing investment property.
*revaluation above historical cost is recorded as a gain as opposed to a surplus like with PPE
GAAP-does not distinguish between investment property and other long lived assets.
Capital lease (finance lease) vs operating lease
capital lease is recorded as an asset and liability. depreciation is recognized on the asset and interest expense on the liability.
Operating lease does not show on the balance sheet, just as an expense on the income statement.
*total cash flow ends up exactly the same where capital lease or operating lease.
income subject to tax based on a tax return
the tax liability caused by taxable income. Also known as current tax expense. Do not confuse with income tax expense.
Income tax paid
the actual cash flow for income taxes including payments or refunds from other years
Tax loss carryforward
A current or past loss that can be used to reduce taxable income in the future. Can result in a deferred tax asset.
Net amount of an asset or liability used for tax reporting purposes. Think of it as the "carrying value" for tax purposes.
pretax financial income based on financial accounting standards
Income tax expense
expense recognized in the income statement that includes taxes payable and changes in deferred tax assets and liabilities.
Income tax expense = taxes payable + change in DTL - change in DTA
Deferred tax liabilities
balance sheet amounts that result from an excess of income tax expense over taxes payable that are expected to result in future cash outflows.
-Revenue (or gains) are recognized in the income statement before they are included on the tax return
-Expenses (or losses) are tax deductible before they are recorded on the income statement.
-Accelerated depreciation is used on the tax return and straight line is used on the income statement
=carrying value - tax base
*if negative then is a deferred tax asset.
Deferred tax assets
balance sheet amounts that result from an a excess of taxes payable over income tax expense that are expected to be recovered from future operations. Can also result from tax loss carryforwards.
-Revenues (or gains) are taxable before they are recognized on the income statement
-Expenses (or losses) are recognized in the income statement before they are tax deductible.
-tax carry forwards are available to reduce taxable income
-typically from post-employment benefits, warranty expenses and tax loss carry forwards.
reduction of deferred tax assets based on the likelihood the assets will not be realized.
A difference between taxable income (tax return) and pretax income (income statement) that will not reverse in the future. Permanent differences do not cause deferred tax assets or deferred tax liabilities.
Ie. Tax credits.
a difference between the tax base and the carrying value of an asset or liability that will result in either taxable amounts or deductible amounts in the future.
Effects of tax rate changes
An increase in the tax rate will increase both deferred tax assets and deferred tax liabilities. A decrease in the tax rate will decrease both.
Effective tax rate vs Statutory tax rate
effective tax rate = income tax expense/pretax income
Statutory tax rate is the tax rate of the jurisdiction.
Valuation allowance for deferred tax assets
GAAP- if it is more than 50% likely that a DTA may not be realized (due to insufficient generation of future taxable income), then the DTA must be reduced by a valuation allowance.
Deferred tax disclosures
-Deferred tax liabilities, deferred tax assets, any valuation allowance, and the net change in valuation allowance over the period.
-any unrecognized deferred tax liability for undistributed earnings of subs and jv's
-current year tax effect of each type of temporary difference.
-Components of income tax expense
-Reconciliation of reported income tax expense and the tax expense based on the statutory rate.
-tax loss carry forwards and credits
GAAP vs IFRS Tax accounting differences
Revaluation of fixed assets and intangible assets:
GAAP-not applicable as no revaluation is allowed.
IFRS-deferred taxes are recognized in equity.
Undistributed profit from investment in a sub:
GAAP- no deferred taxes for foreign subs that meet indefinite reversal criterion (same with a JV). No deferred taxes for domestic subs if the amounts are tax free.
IFRS- deferred taxes are recognized unless the parent is able to control the distribution of profit and is probable that the temporary difference will not reverse in the future. (Same as JV)
Deferred tax asset recognition:
GAAP-recognized in full, then reduced is "more than 50% chance" that some or all of that asset won't be realized.
IFRS- recognized if "probable" that sufficient taxable profit will be available to recover the tax asset
Tax rate used to measure deferred taxes:
GAAP-enacted tax rate only
IFRS- enacted or substantively enacted tax rate
Presentation of deferred taxes on balance sheet:
GAAP- classified as current or non-current based on the classification of the underlying asset or liability.
IFRS- classified as non-current.