1. ANALYSIS OF INVENTORIES 1Đặng Thị Thu Hằng

2. INTRODUCTION Compare the effects of the FIFO/ LIFO choice along these dimensions and demonstrates how the analyst can adjust from one method to another. 2Đặng Thị Thu Hằng

3. Inventory Management Inventory is one of the most expensive assets of many companies. It represents as much as 40% of total invested capital. 3Đặng Thị Thu Hằng

4. Inventory Management Inventory is any stored resource that is used to satisfy a current or future need. Raw materials, work-in-process, and finished goods are examples of inventory. Two basic questions in inventory management are (1) how much to order (or produce), and (2) when to order (or produce). 4Đặng Thị Thu Hằng

5. FIFO/ LIFO EI = BI + P – COGS BI + P = COGS + EI P: the purchase of goods COGS: cost of goods sale BI: the beginning sale EI: the ending inventory 5Đặng Thị Thu Hằng

6. COSTS INCLUDED IN INVENTORIES >< COSTS RECOGNIZED AS EXPENSES IN THE PERIOD Costs included in inventories: (product costs) -Purchase cost less trade discounts and rebates -Conversion costs including labor and overhead -Other costs necessary to bring the inventory to its present location and condition 6Đặng Thị Thu Hằng

7. Costs recognized as expenses in the period (period costs) -Abnormal waste of materials, labor or overhead. -Storage costs (unless required as part of production) -Administrative overhead -Selling costs 7Đặng Thị Thu Hằng

8. EXAMPLE: COSTS INCLUDED IN INVENTORY 8Đặng Thị Thu Hằng

9. 9 Vindaloo company manufactures a single product. The following information was taken from the company’s production and cost records last year: Units produced: 5000 Raw materials: 15.000 Conversion cost for finished goods: 20.000 Freight in to plant: 800 Storage cost for finished goods: 500 Abnormal waste: 100 Freight out to customers: 1.100 Đặng Thị Thu Hằng

10. Question: assuming no abnormal waste is included in conversion cost, calculate the total capitalized cost? Cost per unit? 10Đặng Thị Thu Hằng

11. INVENTORY VALUATION METHODS Specific identification FIFO LIFO Weighted average cost 11Đặng Thị Thu Hằng

12. Use the inventory example data in the following figure to calculate the COGS and ending inventory under the FIFO, LIFO, and weighted average cost methods 12 Jan 1 (beginning inventory) 2 units x $2 per unit$4 Jan 7 purchase3 units x $3 per unit$9 Jan 19 purchase5 units x $ 5 per unit$25 Cost of goods availble10 units$38 Units sold during Jan7 units Đặng Thị Thu Hằng

13. 13Đặng Thị Thu Hằng

14. SCENARY 1: STABLE PRICE BI + P = COGS + EI $ 2000 + $ 5000 = $ 4000 + $ 3000 14Đặng Thị Thu Hằng

15. SCENARY 2: RISING PRICES FIFO: BI + P = COGS + EI $ 2000 + $ 6250 = $ 4300 + $ 3950 LIFO: BI + P = COGS + EI $ 2000 + $ 6250 = $ 5150 + $ 3100 15Đặng Thị Thu Hằng

16. COMPARISION OF INFORMATION PROVIDED BY ALTERNATIVE METHODS Balance sheet Information: Inventory account -LIFO: the earliest costs to cost of goods sold, leaving the most recent costs in ending inventory. -FIFO: the earliest costs to ending inventory 16Đặng Thị Thu Hằng

17. Income statement information: Cost of goods sold: -LIFO: the most informative accounting method in that it provides a better measure of current income and future profitability. -FIFO: provides the best measure for the balance sheet 17Đặng Thị Thu Hằng

18. LIFO VERSUS FIFO: INCOME, CASH FLOW AND WORKING CAPITAL EFFECTS LIFOFIFO Cost of goods soldHigherLower Income before taxesLowerHigher Income taxesLowerHigher Net incomeLowerHigher Cash flowsHigherLower Inventory balanceLowerHigher Working capitallowerHigher 18Đặng Thị Thu Hằng

19. The income statement FIFOLIFO Sales$ 10.000 COGS43005150 Income before tax57004850 Tax 40%22801940 Net income34202910 19Đặng Thị Thu Hằng

20. The cash flows FIFOLIFO Sales inflows$ 10.000 Purchases6250 Inflows before tax3750 Tax paid22801940 Net cash flows14701810 20Đặng Thị Thu Hằng

21. The change in balance sheet account FIFOLIFO Cash$ 1470$ 1810 Inventory19501100 Working capital34202910 Retained earnings34202910 Cash: net cash flow for period Inventory: purchases less COGS Retained earning: net income for period 21Đặng Thị Thu Hằng

22. PERPETUAL VERSUS PERIODIC INVENTORY SYSTEMS Periodic inventory system: inventory values and COGS are determined at the end of the accounting period. Perpetual inventory system: inventory values and COGS are updated continuously. 22Đặng Thị Thu Hằng

23. Calculate COGS and ending inventory under the FIFO and LIFO cost flow methods using a perpetual inventory system 23 Jan 1 (beginning inventory)2 units x $ 2 per unit Jan 7 purchase3 units x $ 3 per unit Jan 12 sale4 units Jan 19 purchase5 units x $5 per unit Jan 29 sale3 units Đặng Thị Thu Hằng

24. FINANCIAL RATIOS: FIFO VERSUS LIFO Profitability: gross profit margin: assuming inflation, higher COGS under LIFO will result in lower gross profit. 24Đặng Thị Thu Hằng

25. QUARTERCOSTPRICEUNITSDOLLARS 1$ 11$ 221002200 2$ 12 $ 241002400 3$ 13$ 261002600 4$ 14$ 281002800 TOTAL40010.000 25 SALESCOGSGROSS PROFIT PERCENT FIFO10.000430057005700/10.000 = 57% LIFO10.00051504850 4850/ 10.000 = 48,5% Đặng Thị Thu Hằng

26. Liquidity: working capital: the FIFO is better than the LIFO due to the inventory components of working capital carries outdated costs. Activity: Inventory Turnover: meaning less for LIFO firms due to the mismatching of costs, thus under the LIFO, when prices increase, trend higher irrespective of the trend of physical turnover. 26Đặng Thị Thu Hằng

27. LIFO/ FIFO CHOICE The choice of inventory method was closely related to industry and size factors. Large firms tend to choose the LIFO and conversely LIFO increases inventory management and control costs. 27Đặng Thị Thu Hằng