CHAPTER 9

INVENTORIES

SOLUTIONS

1. C is correct. Transportation costs incurred to ship inventory to customers are an expense and may not be capitalized in inventory. (Transportation costs incurred to bring inventory to the business location can be capitalized in inventory.) Storage costs required as part of production, as well as costs incurred as a result of normal waste of materials, can be capitalized in inventory. (Costs incurred as a result of abnormal waste must be expensed.)

2. B is correct. Inventory expense includes costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. It does not include storage costs not required as part of production.

3. A is correct. IFRS allow the inventories of producers and dealers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products to be carried at net realizable value even if above historical cost. (U.S. GAAP treatment is similar.)

4. B is correct. Under IFRS, the reversal of write-downs is required if net realizable value increases. The inventory will be reported on the balance sheet at £1,000,000. The inventory is reported at the lower of cost or net realizable value. Under U.S. GAAP, inventory is carried at the lower of cost or market value. After a write-down, a new cost basis is determined and additional revisions may only reduce the value further. The reversal of write-downs is not permitted.

5. A is correct. IFRS require the reversal of inventory write-downs if net realizable values increase; U.S. GAAP do not permit the reversal of write-downs.

6. B is correct. Cinnamon uses the weighted average cost method, so in 2008, 5,000 units of inventory were 2007 units at €10 each and 50,000 were 2008 purchases at €11. The weighted average cost of inventory during 2008 was thus (5,000 × 10) + (50,000 × 11)=50,000 + 550,000=€600,000, and the weighted average cost was approximately €10.91=€600,000/55,000. Cost of sales was €10.91 × 45,000, which is approximately €490,950.

7. C is correct. Zimt uses the FIFO method, and thus the first 5,000 units sold in 2008 depleted the 2007 inventory. Of the inventory purchased in 2008, 40,000 units were sold and 10,000 remain, valued at €11 each, for a total of €110,000.

8. A is correct. Zimt uses the FIFO method, so its cost of sales represents units purchased at a (no longer available) lower price. Nutmeg uses the LIFO method, so its cost of sales is approximately equal to the current replacement cost of inventory.

9. B is correct. Nutmeg uses the LIFO method, and thus some of the inventory on the balance sheet was purchased at a (no longer available) lower price. Zimt uses the FIFO method, so the carrying value on the balance sheet represents the most recently purchased units and thus approximates the current replacement cost.

10. B is correct. In a declining price environment, the newest inventory is the lowest-cost inventory. In such circumstances, using the LIFO method (selling the newer, cheaper inventory first) will result in lower cost of sales and higher profit.

11. B is correct. In a rising price environment, inventory balances will be higher for the company using the FIFO method. Accounts payable are based on amounts due to suppliers, not the amounts accrued based on inventory accounting.

12. C is correct. The write-down reduced the value of inventory and increased cost of sales in 2007. The higher numerator and lower denominator mean that the inventory turnover ratio as reported was too high. Gross margin and the current ratio were both too low.

13. A is correct. The reversal of the write-down shifted cost of sales from 2008 to 2007. The 2007 cost of sales was higher because of the write-down, and the 2008 cost of sales was lower because of the reversal of the write-down. As a result, the reported 2008 profits were overstated. Inventory balance in 2008 is the same because the write-down and reversal cancel each other out. Cash flow from operations is not affected by the noncash write-down, but the higher profits in 2008 likely resulted in higher taxes and thus lower cash flow from operations.

14. B is correct. LIFO will result in lower inventory and higher cost of sales. Gross margin (a profitability ratio) will be lower, the current ratio (a liquidity ratio) will be lower, and inventory turnover (an efficiency ratio) will be higher.

15. A is correct. LIFO will result in lower inventory and higher cost of sales in periods of rising costs compared to FIFO. Consequently, LIFO results in a lower gross profit margin than FIFO.

16. B is correct. The LIFO method increases cost of sales, thus reducing profits and the taxes thereon.

17. A is correct. U.S. GAAP do not permit inventory write-downs to be reversed.

18. C is correct. The storage costs for inventory awaiting shipment to customers are not costs of purchase, costs of conversion, or other costs incurred in bringing the inventories to their present location and condition and are not included in inventory. The storage costs for the chocolate liquor occur during the production process and are thus part of the conversion costs. Excise taxes are part of the purchase cost.

19. C is correct. The carrying amount of inventories under FIFO will more closely reflect current replacement values because inventories are assumed to consist of the most recently purchased items. FIFO is an acceptable, but not preferred, method under IFRS. Weighted average cost, not FIFO, is the cost formula that allocates the same per unit cost to both cost of sales and inventory.

20. B is correct. Inventory turnover=Cost of sales/Average inventory=41,043/7,569.5=5.42. Average inventory is (8,100 + 7,039)/2=7,569.5.

21. B is correct. For comparative purposes, the choice of a competitor that reports under IFRS is requested because LIFO is permitted under U.S. GAAP.

22. A is correct. The carrying amount of the ending inventory may differ because the perpetual system will apply LIFO continuously throughout the year, liquidating layers as sales are made. Under the periodic system, the sales will start from the last layer in the year. Under FIFO, the sales will occur from the same layers regardless of whether a perpetual or periodic system is used. Specific identification identifies the actual products sold and remaining in inventory, and there will be no difference under a perpetual or periodic system.

23. B is correct. The cost of sales is closest to CHF 4,550. Under FIFO, the inventory acquired first is sold first. Using Exhibit D, a total of 310 cartons were available for sale (100 + 40 + 70 + 100) and 185 cartons were sold (50 + 100 + 35), leaving 125 in ending inventory. The FIFO cost would be as follows:

100 (beginning inventory) × 22=2,200

40 (4 February 2009) × 25=1,000

45 (23 July 2009) × 30=1,350

Cost of sales=2,200 + 1,000 + 1,350=CHF 4,550

24. A is correct. Gross profit will most likely increase by CHF 9,256. The net realizable value has increased and now exceeds the cost. The write-down from 2008 can be reversed. The write-down in 2008 was 9,256 [92,560 × (4.05 − 3.95)]. IFRS require the reversal of any write-downs for a subsequent increase in value of inventory previously written down. The reversal is limited to the lower of the subsequent increase or the original write-down. The amount of any reversal of a write-down is recognized as a reduction in cost of sales. This reduction results in an increase in gross profit.

25. C is correct. Using the FIFO method to value inventories when prices are rising will allocate more of the cost of goods available for sale to ending inventories (the most recent purchases, which are at higher costs, are assumed to remain in inventory) and less to cost of sales (the oldest purchases, which are at lower costs, are assumed to be sold first).

26. C is correct. Karp’s inventory under FIFO equals Karp’s inventory under LIFO plus the LIFO reserve. Therefore, as of 31 December 2009, Karp’s inventory under FIFO equals:

image

27. B is correct. Karp’s cost of goods sold (COGS) under FIFO equals Karp’s cost of goods sold under LIFO minus the increase in the LIFO reserve. Therefore, for the year ended 31 December 2009, Karp’s cost of goods sold under FIFO equals:

image

28. A is correct. Karp’s net income (NI) under FIFO equals Karp’s net income under LIFO plus the after-tax increase in the LIFO reserve. For the year ended 31 December 2009, Karp’s net income under FIFO equals:

image

Therefore, the increase in net income is:

image

29. B is correct. Karp’s retained earnings (RE) under FIFO equals Karp’s retained earnings under LIFO plus the after-tax LIFO reserve. Therefore, for the year ended 31 December 2009, Karp’s retained earnings under FIFO equals:

image

Therefore, the increase in retained earnings is:

image

30. A is correct. The cash ratio (cash and cash equivalents ÷ current liabilities) would be lower because cash would have been less under FIFO. Karp’s income before taxes would have been higher under FIFO, and consequently taxes paid by Karp would have also been higher and cash would have been lower. There is no impact on current liabilities. Both Karp’s current ratio and gross profit margin would have been higher if FIFO had been used. The current ratio would have been higher because inventory under FIFO increases by a larger amount than the cash decreases for taxes paid. Because the cost of goods sold under FIFO is lower than under LIFO, the gross profit margin would have been higher.

31. B is correct. If Karp had used FIFO instead of LIFO, the debt-to-equity ratio would have decreased. No change in debt would have occurred but shareholders’ equity would have increased as a result of higher retained earnings.

32. B is correct. Crux’s adjusted inventory turnover ratio must be computed using cost of goods sold (COGS) under FIFO and excluding charges for increases in valuation allowances.

image

Note: Minus the change in LIFO reserve is equivalent to plus the decrease in LIFO reserve.

The adjusted inventory turnover ratio is computed using average inventory under FIFO.

Ending inventory (FIFO) = Ending Inventory (LIFO) + LIFO reserve

Ending inventory 2009 (FIFO) = 480 + 55 = 535

Ending inventory 2008 (FIFO) = 465 + 72 = 537

Average inventory = (535 + 537)/2 = 536

Therefore, adjusted inventory turnover ratio equals:

Inventory turnover ratio = COGS/Average inventory = 3,124/536 = 5.83

33. B is correct. Rolby’s adjusted net profit margin must be computed using net income (NI) under FIFO and excluding charges for increases in valuation allowances.

image

Therefore, adjusted net profit margin equals:

image

34. A is correct. Mikko’s adjusted debt-to-equity ratio is lower because the debt (numerator) is unchanged and the adjusted shareholders’ equity (denominator) is higher. The adjusted shareholders’ equity corresponds to shareholders’ equity under FIFO, excluding charges for increases in valuation allowances. Therefore, adjusted shareholders’ equity is higher than reported (unadjusted) shareholders’ equity.

35. C is correct. Mikko’s and Crux’s gross margin ratios would better reflect the current gross margin of the industry than Rolby because both use LIFO. LIFO recognizes as cost of goods sold the cost of the most recently purchased units; therefore, it better reflects replacement cost. However, Mikko’s gross margin ratio best reflects the current gross margin of the industry because Crux’s LIFO reserve is decreasing. This could reflect a LIFO liquidation by Crux, which would distort gross profit margin.

36. B is correct. The FIFO method shows a higher gross profit margin than the LIFO method in an inflationary scenario, because FIFO allocates to cost of goods sold the cost of the oldest units available for sale. In an inflationary environment, these units are the ones with the lowest cost.

37. A is correct. An inventory write-down increases cost of sales and reduces profit and reduces the carrying value of inventory and assets. This has a negative effect on profitability and solvency ratios. However, activity ratios appear positively affected by a write-down because the asset base, whether total assets or inventory (denominator), is reduced. The numerator, sales, in total asset turnover is unchanged and the numerator, cost of sales, in inventory turnover is increased. Thus, turnover ratios are higher and appear more favorable as the result of the write-down.

38. B is correct. Finished goods least accurately reflect current prices because some of the finished goods are valued under the “last-in, first-out” (“LIFO”) basis. The costs of the newest units available for sale are allocated to cost of goods sold, leaving the oldest units (at lower costs) in inventory. ZP values raw materials and work in process using the weighted average cost method. While not fully reflecting current prices, some inflationary effect will be included in the inventory values.

39. C is correct. FIFO inventory=Reported inventory+LIFO reserve=608,572 + 10,120=618,692. The LIFO reserve is disclosed in Note 2 of the notes to consolidated financial statements.

40. A is correct. The SEC does not require companies to use the same inventory valuation method for all inventories, so this is the least likely reason to change accounting policies regarding inventory. The SEC is currently evaluating whether all U.S. companies should be required to adopt IFRS. If the SEC requires companies to adopt IFRS, the LIFO method of inventory valuation would no longer be allowed.

41. A is correct. The inventory turnover ratio would be lower. The average inventory would be higher under FIFO and cost of products sold would be lower by the increase in LIFO reserve. LIFO is not permitted under IFRS.

image

2009 inventory turnover ratio as reported=10.63=5,822,805/[(608,572 + 486,465)/2]

image

42. A is correct. No LIFO liquidation occurred during 2009; the LIFO reserve increased from ¥10,120 million in 2008 to ¥19,660 million in 2009. Management stated in the MD&A that the decrease in inventories reflected the impacts of decreased sales volumes and fluctuations in foreign currency translation rates.

43. C is correct. Finished goods and raw materials inventories are lower in 2009 when compared to 2008. Reduced levels of inventory typically indicate an anticipated business contraction.

44. B is correct. The decrease in LIFO inventory in 2009 would typically indicate that more inventory units were sold than produced or purchased. Accordingly, one would expect a liquidation of some of the older LIFO layers and the LIFO reserve to decrease. In actuality, the LIFO reserve increased from ¥10,120 million in 2008 to ¥19,660 million in 2009. This is not to be expected and is likely caused by the increase in prices of raw materials, other production materials, and parts of foreign currencies as noted in the MD&A. An analyst should seek to confirm this explanation.

45. C is correct. Inventories valued using LIFO are less likely to incur inventory write-downs than inventories valued using weighted average cost or FIFO. Under LIFO, the oldest costs are reflected in the inventory carrying value on the balance sheet. Given increasing inventory costs, the inventory carrying values under the LIFO method are already conservatively presented at the oldest and lowest costs. Thus, it is far less likely that inventory write-downs will occur under LIFO; and if a write-down does occur, it is likely to be of a lesser magnitude.

..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset
3.16.68.49