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7 terms
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2.15 - Inventories: Implications for Financial


Statements and Ratios
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calculate and explain how inflation and deflation of
inventory costs affect the financial statements and ratios of
companies that use different inventory valuation methods;
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If the purchase prices (purchase costs) or production costs of inventory are increasing, the income statement
consequences of using the LIFO method compared to other methods will include higher cost of sales, and
lower gross profit, operating profit, income tax expense, and net income. The balance sheet consequences
include lower ending inventory, working capital, total assets, retained earnings, and shareholders' equity. The
lower income tax paid will result in higher net cash flow from operating activities. Some of the financial ratio
effects are a lower current ratio, higher debt-to-equity ratios, and lower profitability ratios.

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explain LIFO reserve and LIFO
liquidation and their effects on financial
statements and ratios;
LIFO reserve is the difference between the reported LIFO inventory carrying amount and the inventory amount that would have
been reported if the FIFO method had been used (in other words, the FIFO inventory value less the LIFO inventory value)

LIFO Liquidation is when # units sold > # units purchased and decreases LIFO inventory. Results in inventory-related increase in
gross profits

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Terms in this set (7)


calculate and explain how inflation and deflation of inventory costs affect the financial
statements and ratios of companies that use different inventory valuation methods;
If the purchase prices (purchase costs) or production costs of inventory are increasing, the
income statement consequences of using the LIFO method compared to other methods will
include higher cost of sales, and lower gross profit, operating profit, income tax expense, and net
income. The balance sheet consequences include lower ending inventory, working capital, total
assets, retained earnings, and shareholders' equity. The lower income tax paid will result in
higher net cash flow from operating activities. Some of the financial ratio effects are a lower
current ratio, higher debt-to-equity ratios, and lower profitability ratios.
explain LIFO reserve and LIFO liquidation and their effects on financial statements and ratios;
LIFO reserve is the difference between the reported LIFO inventory carrying amount and the
inventory amount that would have been reported if the FIFO method had been used (in other
words, the FIFO inventory value less the LIFO inventory value)

LIFO Liquidation is when # units sold > # units purchased and decreases LIFO inventory.
Results in inventory-related increase in gross profits

convert a company's reported financial statements from LIFO to FIFO for purposes of
comparison
...
describe the implications of valuing inventory at net realisable value for financial statements and
ratios;
Any write-down reduces the value of the inventory, and the loss in value (expense) is generally
reflected in the income statement in cost of goods sold. An inventory write-down reduces both
profit and the carrying amount of inventory on the balance sheet and thus has a negative effect
on profitability, liquidity, and solvency ratios. However, activity ratios (for example, inventory
turnover and total asset turnover) will be positively affected by a write-down because the asset
base (denominator) is reduced
analyze and compare the financial statements and ratios of companies, including those that use
different inventory valuation methods;
...
explain issues that analysts should consider when examining a company's inventory disclosures
and other sources of information.
It is critical for the analyst to be aware of industry trends toward product obsolescence and to
analyze the financial ratios for their sensitivity to potential inventory impairment. Companies can
minimise the impact of inventory write-downs by better matching their inventory composition
and growth with prospective customer demand. To obtain additional information about a
company's inventory and its future sales, a variety of sources of information are available.
Analysts should consider the Management Discussion and Analysis (MD&A) or similar sections
of the company's financial reports, industry-related news and publications, and industry
economic data.
COGS (adjusted)
= COGS (LIFO method) - Charges included in COGS for inventory write-downs - Change in
LIFO reserve

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