ANALYSIS OF INVENTORIES

COMPARISON OF INFORMATION PROVIDED BY ALETERNATIVE METHODS From BS perspective, inventories based on FIFO are preferable to those presented under LIFO, as carrying values most closely reflect current cost. In other words, FIFO provides a measure of inventory that is closer to its current (economic) value During periods of changing prices and stable or growing inventories, LIFO is the most informative accounting method for income statement purpose, in that it provide a better measure of current income and future profitability

LIFO vs FIFO LIFOFIFO COGSHigherLower Income before TaxLowerHigher Income TaxLowerHigher Net IncomeLowerHigher Cash FlowHigherLower Inventory BalanceLowerHigher Working CapitalLowerHigher

ADJUSTMENT FROM LIFO TO FIFO Adjustment of inventory balance Adjustment of COGS

FINANCIAL RATIO: LIFO VS FIFO Profitability: gross profit margin –LIFO gives more accurate forecast of the firm’s prospects by removing the impact of price changes Liquidity: Working Capital –LIFO Mistates WC because inventory component of working capital reports outdated cost Activity: Inventory Turnover –Meaningless for LIFO  convert to FIFO

LIFO/FIFO Choice Estimated tax saving Inventory materiality Tax loss carryforward Inventory variability Inventory obsolescence Size as proxy for bookeeping costs Leverage Current ratio

ANALYSIS OF LONG-LIVED ASSSETS: THE CAPITALIZATION DECISION

Debate Should some component include in the capitalized cost? Do some types of cost merit capitalization? What accounting method should be used to determine the amount of cost capitalized?

Financial Statement Effect of Capitalization Income Variability Profitability Cash Flow from Operation Leverage ratio

Capitalization of Interest Cost For purpose of analysis, the income statement capitalization of interest should be reversed, resulting in the following effect: Capitalized interest should be added back to interest expenses Adding capitalized interest expense reduces net income The capitalization of interest also distorts the classification of cash flow. The interest coverage ratio should be calculated with interest expense adjusted to add back capitalized interest

Intangible Assets Recognition and measurement Issue Research and Development Patents and Copyrights Franchises and Licenses Brand and Trademark Advertising Cost Goodwill

ANALYSIS OF LONG-LIVED ASSETS: ANALYSIS OF DEPRECIATION AND IMPAIRMENT

Depreciation Methods Annuity of Sinking Fund Depreciation SL Depreciation Accelerated Depreciation Unit of Production and Service Hours Group and Composite Depreciation

Impact of Depreciation Methods on Financial Statement Accelerated Depreciation and Taxes –Beneficial effect on the firm’s tax burden Impact of inflation on depreciation –accelerated depreciation compensate for inflation effect by shortening the tax recovery period

IMPAIRMENT Financial reporting of impaired assets Impairement of asset held for sale Impairment of assets remaining in use Financial statement impact of impairment