Session 15 Inventory Notes - LIFO FIFO
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Session 15: Inventory
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Mini Case 2 Instructions
Deadline: Complete the Mini Case 2 Quiz by Sunday, March 30, 10 PM.
Format: The quiz consists of five multiple-choice questions, duration of 20 minutes, with one attempt only.
Resources: You may refer to the case materials during the quiz.
Penalty for Late Submission: 0.1 points will be deducted for each hour late out of total 5 points.
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Mid-term Exam #2 Details
Date: Thursday, April 3.
Duration: 75-minute, closed-book, closed-notes.
Bring a calculator and a pencil; arrive 5 minutes early.
Content Covered: Everything from Session 8-16 (until inventory).
Types of Questions:
Medium to long questions: Statement of Cash Flows, Accounts Receivables, Revenue Recognition, and Inventories.
Miscellaneous short questions from any covered topics.
Accommodations: Submit requests for ADS accommodations as soon as possible.
Practice Materials: Available on Canvas under relevant sections. Review session hosted by TAs on Friday.
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Agenda
Inventory Discussion
Inventory transactions
Cost Flow Assumptions: FIFO vs. LIFO
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What is Inventory?
Definition: Inventories are assets held for sale in the ordinary course of business.
Accounting Variability: Different businesses may account for inventory differently, such as:
Manufacturing Firms (e.g. Nike, Tesla)
Merchandising Firms (e.g. Walmart, CVS)
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Merchandising Firms
These firms are primarily wholesalers or retailers that purchase “finished goods” ready for resale.
Inventory Accounts: Generally maintain one account (finished goods).
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Manufacturing Firms
The process to create a product, for example, a Tesla Model 3 involves:
Raw materials
Work-in-process
Finished goods
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Types of Inventory in Manufacturing
Categories:
Raw Materials Inventory: Parts and materials used in production.
Work-in-process Inventory: Partially completed goods.
Finished Goods Inventory: Complete products available for sale.
Example: Refer to Tesla's 2025 10-K for categorization.
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Summary of Inventory Types
Merchandising Firms: Hold finished goods with just one inventory account.
Manufacturing Firms: Utilize multiple categories of inventory (raw materials, work-in-process, finished goods).
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Walmart's Common-size Balance Sheet (Assets)
Walmart Inc. (Jan 31, 2023-2019)
Item | 2023 (%) | 2022 (%) | 2021 (%) | 2020 (%) | 2019 (%) |
|---|---|---|---|---|---|
Cash and Cash Equivalents | 3.55 | 6.03 | 7.03 | 4.00 | 3.52 |
Receivables, Net | 3.26 | 3.38 | 2.58 | 2.66 | 2.87 |
Inventories | 23.26 | 23.08 | 17.80 | 18.79 | 20.19 |
Current Assets | 31.11 | 33.11 | 35.67 | 26.13 | 28.23 |
Total Assets | 100.00 | 100.00 | 100.00 | 100.00 | 100.00 |
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Walmart's Common-size Income Statement
Walmart Inc. (12 months ended Jan 31, 2023-2019)
Item | 2023 (%) | 2022 (%) | 2021 (%) | 2020 (%) | 2019 (%) |
|---|---|---|---|---|---|
Net Sales | 100.00 | 100.00 | 100.00 | 100.00 | 100.00 |
Cost of Sales | -76.54 | -75.56 | -75.70 | -75.90 | -75.50 |
Consolidated Net Income | 1.86 | 2.46 | 2.47 | 2.92 | 1.41 |
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Inventory and Accounts Payable Transactions
Inventory Purchase: (on credit or cash)
Journal Entry: Inventory XX A/P (or cash) XX
Sales of Merchandise (only cost):
Journal Entry: COGS XX Inventory XX
Payments to Suppliers:
Journal Entry: A/P XX Cash XX
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Summary of Inventory and Accounts Payable Transactions
Purchases of inventory add to assets on the balance sheet until sold.
When sold, the cost shifts to the income statement as COGS (Cost of Goods Sold).
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User’s Perspective on Inventory Numbers
Inventory and Accounts Payable calculations:
Inventory Calculation: BI + Purchases - COGS = EI
Accounts Payable Calculation: Beginning A/P + purchases - payments = Ending A/P.
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Walmart Example: Inventory and A/P Analysis
Analyze transactions from Walmart’s 2024 annual report to determine:
Total inventory purchased during FY 2024 and
Total payments to suppliers regarding inventory purchases.
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Walmart Consolidated Balance Sheets (2024)
Key Figures as of January 31, 2024
Item | Amount ($ Millions) |
|---|---|
Current Assets | 252,399 |
Total Assets | 252,399 |
Accounts Payable | 92,415 |
Total Liabilities | 92,415 |
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Inventory Equation
Formula: Inventory (A) = Beginning Inventory + Purchases - COGS = Ending Inventory (EI).
Cost of Goods Available for Sale (CGAS).
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Inventory Metrics
Beginning Inventory (BI): Starting value at the period start.
Cost of Goods Available for Sale (CGAS) helps in determining ending inventory.
Sales Example: Impact of different sales timings and conditions on COGS.
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Cost Flow Assumptions in Inventory
Common methods to calculate inventory costs:
FIFO: First-in, first-out (oldest units sold first).
LIFO: Last-in, first-out (most recent units sold first).
Consider how these methods impact COGS and ending inventory, particularly as unit costs fluctuate.
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Cost Flow Example: P.S. Corp.
Inventory Purchases: Records of purchases at different costs within a period.
Analyze impact of such purchases on ending COGS and inventory balances.
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Cost Evaluation Based on FIFO & LIFO
Example: Dive into specific numbers for COGS calculations under FIFO and LIFO during periods of rising prices.
FIFO usually results in lower COGS and higher net income compared to LIFO.
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Detailed Inventory Examination
FIFO vs. LIFO Analysis
Explore inventory sales impacts on COGS and ending inventory by method:
FIFO leads to lower COGS when costs rise, LIFO leads to higher.
Present the calculations for specific cases.
The tax advantage of LIFO (Last-In, First-Out) arises from how it calculates the Cost of Goods Sold (COGS) against revenues during periods of rising prices. Under the LIFO method, the most recently purchased inventory (which often has a higher cost due to inflation) is considered sold first. This results in a higher COGS, thus reducing reported taxable income and subsequently lowering the income taxes due in the short term. This can provide a significant cash flow benefit to businesses as they retain more of their earnings by deferring tax payments.