2015, Study Session # 9, Reading # 29

INVENTORIES
NRV
RC
HC
WC
CA
LIFO

=
=
=
=
=
=

Net Realizable Value

Replacement Cost
Historical Cost
Working Capital
Current Assets
Last-In-First Out

FIFO
COGS
CF
NI
BV
CV

COGS also referred as cost of sales (COS) under IFRS is = Beg. Inventory +
purchases ending inventory.

This equation can be rearranged to solve any four variables.

= First-In-First Out
= Cost of Goods Sold
= Cash Flows
= Net Income
= Book Value
= Carrying Value

29.a

Product costs are capitalized in inventory a/c & include:

Purchase price trade discounts & rebate.

Conversion costs including labor & overhead.

Other costs to bring inventory to present location & condition.

Period costs are expensed in the period incurred as:

Abnormal costs occurred due to wastage of materials, labor or other production
conversion inputs.

Storage, selling & administrative overhead.

29.b

Cost flow Methods

U.S.GAAP (cost flow assumption)

Specific identification.
First-in, First-out.
Weighted Avg. cost.
Last-in, First-out.

IFRS (cost flow formula)

Specific identification.

First-in, First-out.

Weighted Avg. cost.

Cost flow methods under U.S.GAAP

Specific identification method

Unit sold is matched with

units actual cost.

Suitable for items not
interchangeable

FIFO Method

1st item purchased is the 1st

item sold.

Ending inv. includes most
recent purchases, COGS
earliest purchases.

LIFO Method

Weighted Avg. Cost Method

Recent purchases sold 1st.

COGS measured using recent
prices.


Prices LIFO COGS > FIFO
COGS.

 earnings  taxes,
CF.

Ending inventory at earliest
cost.

Avg. cost of goods available =

total cost / quantity.

COGS = avg. cost units sold.

End. Inv. = avg. cost units
remaining.

LIFO method is not allowed under IFRS.

Prices,
LIFO COGS,  N.I,  inventory,  current ratio
inventory turnover & vice versa under FIFO.

29.c

Inflationary periods LIFO COGS is higher, GP & NP is lower than FIFO, ending inventory is lower & vice
versa in deflationary periods.

Taxes are higher & CFs are lower under FIFO (rising prices & growing inventory).

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2015, Study Session # 9, Reading # 29

29.d

Inventory Systems

Periodic Inventory System

Perpetual Inventory System

Inventory values & COGS are

determined at end of
accounting period.

Beg.inv + purchase = cost of
goods available for sale.

COGS = cost of goods
available ending inventory.

Purchases are recorded in a
purchase account.

Inventory values & COGS are

updated continuously.

Inventory purchases & sold
directly recorded in
inventory, no purchase
account.

Under FIFO & specific identification both systems produce same ending inventory & COGS values.

Under LIFO & weighted avg. method different values under both systems.

29.e

Stable prices, same results for inventory, COGS & GP under all
three cost flow methods & vice versa in trending prices.

Ending Inventory

FIFO provides most useful measure of ending inventory (current cost).

LIFO inventory may significantly differ from economic value.

Cost of goods Sold

Prices LIFO COGS are higher than FIFO & better approximation of
current cost.

Weighted avg. produce values of COGS & inventory b/w FIFO & LIFO.

Gross Profit

Higher COGS under LIFO, lower GP.

All profitability measures are affected by choice of cost flow method.

29.f

Measurement of Inventory

IFRS

U.S.GAAP

Lower of cost or NRV.

NRV = expected sale price-estimated selling cost.

If NRV is < BV, inventory write down to NRV & loss in
I.S.

Subsequent recovery write up & gain in I.S.

Inventory cant be written up by more than previous
write down.

Lower of cost or market.

Market is usually current cost but cant be greater
than NRV or less than NRV normal profit margin.

If cost > market, write down & loss in I.S, no write up
allowed.

Analyst should consider ratio impact of write down or write up.

Reporting inventory above H.C is permitted in certain industries (both IFRS & U.S.GAAP).

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2015, Study Session # 9, Reading # 29

29.g

Inventory disclosure is found in footnotes & useful in comparison & inventory management.

Required inventory disclosures are similar under both standards (except for the amount of and circumstances led to any write-down of
inventories).

Firm can change inventory cost flow methods retrospectively under IFRS as well as U.S. GAAP (latter subject to exception, see below).

For those prior periods not presented, adjustments are made to the beginning balance of retained earnings for the earliest year presented.

Change will provide reliable & relevant information (required under IFRS)Companies are required to disclose why the new method is superior to
the older one (U.S.GAAP).

Exception to retrospective application (U.S. GAAP) changes to LIFO from another method.

29.h

Impact on Ratios (Rising prices & stable or
quantities)

Profitability

Higher COGS in LIFO, so

profitability measures are
lower (e.g. lower gross,
operating & N.P margin).

Liquidity

Activity

Solvency

Lower inventory value in B.S

under LIFO so current ratio &
W.C are lower.

Quick ratio is unaffected.

Inventory turnover is higher

& days of inventory are lower
under LIFO.

Total assets & equity are

lower under LIFO.

Debt ratio & debt to equity
ratios are higher under LIFO.

Analyst can check inventory management through disclosure, ratio

analysis & industry avg.

Too high inventory turnover may be the result of inadequate
inventory held or write downs or effective inventory management.

Higher turnover with slow sales growth, inadequate inventory
quantities & faster growth with higher turnover reflects greater
efficiency.

Level of G.P margin is a function of product type & industry
competitiveness.

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