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This 9 page Class Notes was uploaded by Petey Martin on Thursday October 22, 2015. The Class Notes belongs to ACC 201 at University of Rochester taught by WOJDAT K in Summer 2015. Since its upload, it has received 22 views. For similar materials see FINANCIAL ACCOUNTING in Accounting at University of Rochester.
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Date Created: 10/22/15
Petey Martin Notes 102015 0 Compare Ending Inventory value under FIFO to that under LIFO O O 0 Inventory account balance is based on more recent costs under FIFO than under LIFO BUT COGS is usually based on more recent costs under LIFO than under FIFO FIFO leads to more accurate balance sheet than does LIFO inventory account balances more closely approximate replacement cost under FIFO than under LIFO LIFO usually leads to more accurate income statement than does FIFO COGS usually more closely approximates replacement cost with LIFO method than with FIFO LIFO is considered to lead to higher quality of earnings when there are rising acquisition costs for inventory 0 Except when there is a LIFO liquidation In a period of rising prices acquisition costs inventory will carry a higher dollar value under FIFO than LIFO FIFO sales are assumed to come from early purchases units assumed to remain are the ones purchased later LIFO sales are assumed to come from last purchases units assumed to remain are the ones purchased earHen In a period of falling prices inventory will carry a lower dollar value under FIFO than LIFO The difference in inventory values between FIFO and LIFO leads to an associated difference in COGS 0 Compare FIFO to LIFO Net income 0 O Risinq Prices Higher ending inventory dollar value under FIFO vs LIFO works toward higher net income under FIFO vs LIFO Higher beginning inventory dollar value under FIFO vs LIFO works toward lower net income under FIFO vs LIFO Fallinq prices Lower ending inventory dollar value under FIFO vs LIFO works toward lower net income under FIFO vs LIFO Lower beginning inventory dollar value under FIFO vs LIFO works toward higher net income under FIFO vs LIFO 0 First year of operation no beginning inventory Rising prices acquisition cost higher ending inventory under FIFO than under LIFO Leads to wher rst year net income under FIFO than under LIFO Falling prices acquisition cost lower ending inventory under FIFO than under LIFO Leads to lower rst year net income under FIFO than under LIFO I Over all years from company39s beginning until a point in time No beginning inventory in company s rst year 0 Cumulative Net Income Cumulative Sales Cumulative COGS Cumulative Expenses 0 Cumulative COGS Cumulative Purchases Ending Inventory With rising prices inventory acquisition costs the ending inventory dollar value is higher under FIFO than under LIFO so cumulative COGS is lower and cumulative net income and RE is higher under FIFO than LIFO With rising prices the LIFO assumption will result in lower cumulative taxable income and lower cumulative taxes than will the FIFO assumption for countries accepting LIFO as an alternative for tax purposes 0 However under the LIFO Conformity Rule US Federal law requires use of LIFO assumption for nancial statement purposes if it is used for tax purposes With falling prices inventorv acquisition costs the ending inventory dollar value is lower under FIFO than under LIFO so cumulative COGS is higher and cumulative net income and RE is lower under FIFO than LIFO o LIFO liquidation 0 With falling prices the LIFO assumption will result in higher cumulative taxable income and higher cumulative taxes Number of units purchased in current period exceeds number sold in current period 0 If the number of units purchased in a period exceeds the number sold in that period then 0 All units sold under LIFO are assumed to O 0 Therefore in these circumstances we have 0 With constantly rising prices inventory 0 come from later current period purchases All units sold under FIFO are assumed to come from beginning inventory and early current period purchases acquisition costs current period net income under FIFO is higher than current period net income under LIFO With constantly falling prices inventory acquisition costs current period net income under FIFO is lower than current period net income under LIFO Consider the following table to see the comparison between LIFO and FIFO when units purchased in a period exceed units sold in that period FIFO LIFO Beg Current Period Beg Purchases Inventor Inventory Early Late y FIFO SOLD SOLD KEPT LIFO KEPT KEPT SOLD key Rising Low Cost Lowest Med Cost High Cost Prices Cost Falling High Highest Med Cost Low Cost Prices Cost Cost 0 SOLD and KEPT refers to assumption not not the same cost I to physical ow LIFO liquidation refers to situation where a rm using LIFO sells more units in a period than it purchases in that period When LIFO liquidations occur there is no general rule on how current period net income under FIFO compares to current period net income under LIFO even if prices costs consistently rise or consistently fall Key Issue is that under LIFO it is possible for beginning inventory to be assigned very old cost Rising inventory acquisition costs very old cost can be very very low 0 Falling inventory acquisition costs very old cost can be very very high 0 Consider the following table to see the comparison between LIFO and FIFO when there is a LIFO liquidation FIFO LIFO Beg Current Period Beg Purchases Inventor Inventory Early Late y FIFO SOLD SOLD SOME SOLD LIFO SOME SOLD SOLD SOLD Rising Low Cost Lowest Med Cost High Cost Prices Cost Falling High Highest Med Cost Low Cost Prices Cost Cost not the same cost I Rising acquisition costs More high cost late current period purchases are assumed sold under LIFO than under FIFO but there is a partial g complete offset Sales assumed to come from LIFO beginning inventory are assigned a lower cost than sales assumed to come from FIFO beginning inventory Falling acquisition costs More low cost late current period purchases are assumed sold under LIFO than under FIFO but there is partial g complete offset Sales assumed to come from LIFO beginning inventory are assigned a mgher cost than sales assumed to come from FIFO beginning inventory Petey Martin Notes 102215 Firms must disclose the effects of LIFO liquidations if material in the notes to the nancial statements With a LIFO liquidation income taxes under LIFO may be higher in a given year than income taxes under FIFO even given consistently rising inventory acquisition costs Further the effect of a LIFO liquidation can be avoided by purchasing additional inventory even if the purchase occurs after the last sale The tax code allows LIFO to be calculated as though all sales occurred in the last moment of the accounting period LIFO rms must consider the effect of LIFO liquidations on taxes when considering the value of improved inventory management techniques that lower the inventory normally carried As a LIFO liquidation will then arise LIFO based statements can be converted to FIFO based statements using data presented in the nancial statements 0 Differences in the inventory cost ow assumptions used by different rms make it dif cult to compare rms reported results Therefore under GAAP rms that use LIFO are required to also disclose in the notes to their nancial statements what their inventory values would have been under FIFO if the difference between that value and the LIFO value is material This disclosure can be used to calculate the difference in COGS between the two methods because inventorv cost ow assumptions do not affect the dollar value of urchases Beginning Inventory Different Plus Purchases Same Less Endinq Inventorv Different Equals Cost of Goods Sold Different Many rms simply disclose how much higher the rm s inventory value would have been if the rm valued inventory using FIFO instead of LIFO LIFO Reserve is the term for the excess of the FIFO inventory value over the LIFO inventory value Adding the LIFO reserve to the LIFO inventory balance gives the inventory balance under FIFO o Combining the effect of the LIFO Reserves on both beginning and ending inventory converts LIFO based COGS to FIFO based COGS 0 Begin Inventory LIFO plus Beginning LIFO Reserve Plus Purchases Less Ending Inventory LIFO plus Ending LIFO Reserve COGS under FIFO 0 COGS under LIFO Plus Beginning LIFO Reserve Excess of FIFO over LIFO Less Ending LIFO Reserve Excess of FIFO over LIFO COGS under FIFO 0 By also considering the effect on tax expense of the difference between FIFO COGS and LIFO COGS net income of rms using LIFO can be converted to a FIFO basis 0 This allows analysts to adjust COGS and Net Income to allow comparison of rms using LIFO with those using FIFO 0 LIFO COGS plus beginning LIFO reserve minus ending LIFO reserve FIFO COGS 0 Errors in calculating inventory value 0 Errors in measuring the value of inventory affect both the balance sheet and the income statement 0 Net Income effect is opposite of COGS effect NI SALES COGS Other Expenses If ending inventory value is overstated COGS is understated and net income is overstated by amount of COGS understatement adjusted for income taxes If ending inventory value is understated COGS is overstated and net income is understated by amount of COGS overstatement adiusted for income taxes If beginning inventory value is overstated cost of goods available for sale is overstated COGS is overstated and net income is understated by amount of COGS overstatement adjusted for income taxes If beginning inventory value is understated cost of goods available for sale is understated COGS is understated and net income overstated by amount of COGS understatement adjusted for income taxes 0 Important consideration errors in measuring period 1 ending inventory become errors in measuring period 2 beginning inventory ending inventory 0 value for one period IS beginning inventory value for the following period Net income effect of inventory valuation errors cancel over 2 periods each period wrong by same amount opposite direction assuming a constant tax rate Cumulative COGS OK gt Cumulative Net Income OK gt retained earnings is correct after the second 1 0 As is inventory value after the second period Lower of Cost or market 0 0 Inventory must be valued at market value de ned as replacement cost IF this is lower than the acquisition cost of inventory exception to the cost principle because of conservatism constraint A more thorough treatment requires consideration of net realizable value selling price less cost to sell in addition to replacement cost IFRS requires that market be de ned as net realizable value and GAAP appears to be about to follow Lower of Cost or Market Inventory value will always follow Item by Item 3 Group 3 Total Because products with market value 2 cost can offset those with market value 3 cost ONLY if 1 cost market comparison is done at group level both products are in the same group or 2 cost market comparison is done at total level IFRS requires item by item A holding loss is recognized in the period that the inventory account is reduced to re ect replacement cost or net realizable value that is lower than the value at which the inventory is being carried its cost unless previously written down Holding loss is an addition to COGS in income statement presentation for period in which the loss is recognized Presentation may include only COGS without inventory and purchases details Holding Loss Item by Item 2 Group 2 Total Holding gains are not recorded under GAAP Recognition of a holding loss moves expense recognition to period where market value declines m from period where sale occurs o COGS will be lower by the amount of the holding loss when inventory with the reduced asset balance is sold 0 Lower of cost or market is applied under any of the cost methods for nancial statement purposes 0 Lower of cost or market can be used for US tax purposes but lower of cost or market can not be used for US tax purposes if LIFO is being used
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