Reading 32 Inventories Flashcards
(51 cards)
How is inventory reported under IFRS?
At the lower of cost or net realizable value (NRV)
NRV is equal to the expected sales price less estimated selling and completion costs.
What happens if NRV is less than the balance sheet value of inventory?
The inventory is ‘written down’ to NRV, and the loss is recognized in the income statement
This can be as a separate line item or by increasing cost of goods sold (COGS).
What is the maximum amount inventory can be written up after a write-down?
It cannot be written up by more than it was previously written down
This applies under IFRS.
What is a valuation allowance account?
A contra-asset account similar to accumulated depreciation used for inventory write-downs
It separates the original cost of inventory from the carrying value.
How do U.S. GAAP and IFRS differ in reporting inventory for companies using LIFO or the retail method?
U.S. GAAP reports inventory at the lower of cost or market; market is defined differently than NRV
Market cannot be greater than NRV or less than NRV minus a normal profit margin.
What is the formula for calculating market value under U.S. GAAP?
Market is usually equal to replacement cost, but it cannot exceed NRV or be less than NRV minus a normal profit margin
If replacement cost exceeds NRV, market is NRV.
What is the retail method of inventory valuation?
A method for companies that resell merchandise, involving estimating COGS and ending inventory based on sales and profit margins
It computes cost of goods available for sale and adjusts for sales minus normal profit margin.
What happens when the market value of inventory decreases below its cost?
The inventory is written down to market on the balance sheet
The decrease is recognized in the income statement by increasing COGS or separately for large changes.
What is the impact of a subsequent recovery in value under IFRS?
Inventory can be written up to the original cost, recognizing a gain in the income statement
The write-up is limited to the amount of the original write-down.
What is the impact of a subsequent recovery in value under U.S. GAAP?
No write-up is allowed; carrying value remains at the lower amount
Higher profit is recognized when the inventory is sold.
How does LIFO affect the likelihood of recognizing inventory write-downs?
LIFO firms are less likely to recognize write-downs than firms using FIFO or weighted average cost
This is due to LIFO ending inventory being based on older, lower costs.
What are the effects of an inventory write-down on financial statements?
Decreases current and total assets, affects ratios like current ratio and inventory turnover
It also decreases equity and increases COGS, affecting margins.
What happens to the current ratio after an inventory write-down?
It decreases
The quick ratio remains unaffected.
How does inventory write-down affect inventory turnover?
It increases inventory turnover
This decreases days’ inventory on hand and cash conversion cycle.
What is the expected impact on net income from an inventory write-down?
The percentage decrease in net income is expected to be greater than the percentage decrease in assets or equity
This results in decreased return on assets (ROA) and return on equity (ROE).
What is the exception for reporting inventory above historical cost?
It applies to certain industries, allowing inventory to be reported at NRV with unrealized gains and losses recognized
This applies mainly to commodities like agricultural products and precious metals.
What happens to reported ROA and ROE in subsequent periods following a write-down?
ROA and ROE may increase from decreased COGS leading to higher profitability
This occurs alongside decreases in assets and equity from the write-down.
What happens to LIFO COGS compared to FIFO COGS during inflationary periods?
LIFO COGS is higher than FIFO COGS because the last units purchased have a higher cost than the first units purchased.
How does LIFO affect ending inventory during inflation?
LIFO ending inventory is lower than FIFO ending inventory because it is valued using older, lower costs.
What occurs to LIFO and FIFO COGS during deflationary periods?
LIFO COGS will be lower, and LIFO ending inventory will be higher.
What is the impact of stable prices on LIFO, FIFO, and average cost methods?
The LIFO, FIFO, and average cost methods will yield the same results for inventory, COGS, and gross profit.
What type of inventory does FIFO provide during periods of rising or falling prices?
FIFO provides the most useful measure of ending inventory made up of the most recent purchases.
How does the average cost method compare to LIFO and FIFO when prices are changing?
The average cost method will produce values of COGS and ending inventory between those of FIFO and LIFO.
What is the effect of LIFO on gross profit compared to FIFO during inflation?
Higher COGS under LIFO will result in lower gross profit compared to FIFO.
