fsa 6: analysis of inventories

Under IFRS, inventory is measured at what value?

The lower of cost and net realizable value (NRV).

What is net realizable value (NRV)?

Estimated selling price - estimated completion and selling costs.

when and where is inventory written down?

• written down if inventory value < carrying value

• written down to NRV

• loss is recognised in COGS (income statement)

• reversible in IFRS only as reduction in COGS

Under US GAAP, inventory is measured at what value?

NOT LIFO: The lower of cost and net realizable value (NRV).

LIFO: Lower of cost or market value

what is market value?

• current replacement cost subject to upper and lower limits.

• upper limit: NRV

• lower limit: NRV - normal profit margin

What are the effects of an inventory write-down on

1. net income

2. inventory

3. profitability ratios

4. liquidity and solvency ratios

5. activity ratios eg. inventory turnover

• Net income decreases.

• Inventory decreases

• profitability ratios: negatively

• liquidity and solvency ratios : negatively

• activity ratios: positively as inventory decreases

Why might companies delay recording inventory write-downs?

To avoid reducing profits and weakening ratios.

Which inventories are exempt from IAS 2?

• Agricultural products

• forest products

• mineral products

• commodity broker inventories.

How are agricultural inventories commonly measured?

NRV or fair value less costs to sell.

What are the three inventory methods?

• FIFO : oldest inventory sold first

• LIF: newest inventory sold first

• weighted average cost.

In periods of rinflation, how do FIFO and LIFO affect

1. COGS

2. Ending Inventory

3. Gross Profit/Net Income

4. Inventory turnover

Method	COGS	Ending Inventory	Gross Profit / Net Income	Inventory turnover
FIFO	Lower	Higher	Higher	Lower
LIFO	Higher	Lower	Lower	Higher

Why are FIFO and LIFO considered more “realistic” for different statements during inflation?

Method	More Realistic For	Why
FIFO	Balance sheet	Ending inventory reflects recent higher replacement costs
LIFO	Income statement	COGS reflects current inflated inventory costs matched against current revenues

what needs to be disclosed for both IFRS and US GAAP

1. Method of inventory valuation

2. total carry amount of inventories and by type

3. inventories at fair value - cost to sell

4. How much inventory expense was recognised (COGS)

5. Amount of inventory write downs

6. amount reversal of any write downs (IFRS only)

7. reason for any reversals (IFRS only)

8. inventory used as collateral

9. disclosure of significant estimates applicable to inventories (US GAAP)

10. income resulting from the liquidation of LIFO inventory (US GAAP)

inventory turnover formula

$$\frac{\text{COGS}}{\text{average inventory}}$$

What does a

1. high

2. very high

inventory turnover ratio generally indicate?

high: Efficient inventory management and lower investment in inventory.

very high: Inadequate inventory levels or inventory write-downs.

formula for days of inventory on hand?

$$\frac{365}{\text{Inventory turnover ratio}}$$

inversely related to inventory turnover ratio

effect of FIFO LIFO weighted average on

1. Cost of Sales (COGS)

2. Ending Inventory

3. Gross Profit

4. Net Income

5. Inventory Turnover

6. Days Inventory on Hand

7. Current Ratio

8. Return on Assets (ROA)

9. Debt-to-Equity Ratio

10. Balance Sheet Realism

11. Income Statement Realism

Item / Ratio	FIFO	Weighted Average	LIFO
Cost of Sales (COGS)	Lowest	Middle	Highest
Ending Inventory	Highest	Middle	Lowest
Gross Profit	Highest	Middle	Lowest
Net Income	Highest	Middle	Lowest
Inventory Turnover	Lowest	Middle	Highest
Days Inventory on Hand	Highest	Middle	Lowest
Current Ratio	Highest	Middle	Lowest
Return on Assets (ROA)	Highest	Middle	Lowest
Debt-to-Equity Ratio	Lowest	Middle	Highest
Balance Sheet Realism	Most realistic inventory values	Moderate	Least realistic inventory values
Income Statement Realism	Less realistic COGS	Moderate	Most realistic COGS