owns balance
sheet; if sold transferred to COGS to match against sales revenues for those units)
Product Costs: recognize expense when inventory is sold: matched to when sales revenue is recognized for that particular inventory
Periodic system: assume all purchases this period occur before any sales; calculate COGS expense at end of period
Perpetual system: keeps running balance of inventories; debit COGS expense each time a sale is made
Specific Indentation: used when unit costs are high, volumes low, products easily differentiated; preferred method under GAAP and IFRS; costly,
not always practical
WAC per unit = (Weighted Cost of goods) / (Number of units)
FIFO: more relevant inventory balance bc FIFO reports most recent purchases as inventory
LIFO: Inventory balance may be far below current replacement cost (old costs remain on balance sheet as inventory until a liquidation of layers);
when costs are rising, higher COGS, lower gross profit, net income, taxes (Higher COGS=lower income=lower taxes)
LIFO not permitted under IFRS
FIFO: when unit costs are falling, FIFO yields lower income, income taxes and lower ending inventory values than LIFO
Weighted Avg results in values between LIFO and FIFO
LIFO conformity rule: the IRS requires companies using LIFO for tax purposes to also use LIFO for financial reporting
LIFO reserve difference in the beg and ending inventories had FIFO been used
Companies who use LIFO for financial reporting often use FIFO internally for inventory management.
If LIFO reserve increased this year:
COGS (change in reserve) less under FIFO
Pretax Income (CIR) more under FIFO
Income Taxes (CIR)*Tax Rate more under FIFO
Net Income (CIR)*(1-tax rate) more under FIFO
All through time, the firm has deferred Income Taxes of approx. (ending bal of reserve)*tax rate by using LIFO
One years tax savings: Increase in LIFO Reserve x Tax Rate
Cumulative tax savings: LIFO Reserve x Tax Rate
Gross Profit % = (Gross Profit) / Sales
Inventory Turnover = COGS / (Avg Inventory)
Avg Days to Sell Inventory = 365 / (Inventory Turnover)
LIFO Liquidation: when company sells more than it buys for the year (sells off its older inventory costs); older, lower inventory costs used to
calculate COGS
Decreases COGS, Increases Net Income, Increases Income Taxes
Artificially increases net income bc no increase in cash flow
Inventory Writedown: Dr. COGS (E+, SE-); Cr. Inventory (CA-)
Assets: An expenditure only on balance sheet as asset (Capitalized) if: owned or controlled by the entity, and provides future expected
benefits (cash inflows)
Net Book Value = Gross PPE Accumulated Depreciation
Depreciation for tangible assets
Amortization for limited-life intangible assets
Depletion for natural resources
Assets with indefinite lives are not depreciated.
Depreciation usually doesnt represent decline in current market value.
Straight Line: most used; amortization expense for intangibles
Balance Sheet: cumulative depreciation expense, Income Statement: one year
Unit-of-Production often used for depletion. For depletion of natural resources, depleted resources become inventory, not depletion expense.
Declining-balance: used by IRS; companies switch to straight-line if S-L is larger
Ex: 2=double-declining balance:
(Cost Accumulated Depreciation) * (2 / Estimated Useful Life)
^aka Net Book Value
Journal Entry: Dr. Loss on Sale (E+, SE-); Cr. Gain on Sale (R+, SE+)
IFRS permits revaluing PPE to fair value as of financial statement date; US GAAP no
Most Intangible Assets are only recorded if purchased
Definite Life amortized, S-L, ex: patents, trademarks, licenses
Indefinite Life not amortized; book value reduced to fair value if impaired
Goodwill: cost in excess of net assets acquired; only recorded as the result of a purchase and has indefinite life but is evaluated at least annually
for possible impairment
Fixed Asset Turnover = (Net Sales Revenue) / (Avg Net Fixed Assets)
Estimate Avg Age of Assets = (Acc Depreciation) / (Depreciation Expense for Year)
Estimate of Useful Life = (Original Cost) / (Depreciation Expense for Year)
Liabilities: Debt riskier than equity
Accounts Payable Turnover = (COGS) / (Avg Accounts Payable)
*High accounts payable turnover ration suggests that a company is paying its suppliers in a timely manner.
Avg Number of days Payables Are Outstanding = (365 Days / AP Turnover Ratio)
Dr. Compensation Expense (E+, SE-); Cr. Income Taxes Withheld (CL+), Cr. Pension Taxes Payable (CL+), Cr. Cash (CA-) amts paid to
employees or withheld for them
Dr. Compensation Expense; Cr. Unemployment Tax Payable (CL+), Cr. Pension Taxes Payable (CL+) Employers share of taxes
Contingent Liabilities are potential liabilities that are created as a result of a past event.
GAAP probable = >70%; IFRS >50%
Operating Lease: off balance sheet financing no plant asset or lease liability is recognized; not allowed under IFRS
Capital Lease: includes implicit interest rate; require cash payment at start of lease; lessee capitalizes leased asset and recognizes depreciation;
long-term liability
Bonds Advantages: Debt, not equity, so ownership and control of the company are not diluted; Interest expense is tax deductible, dividend pmts
are not; bonds can often be traded on established exchanges that provide liquidity to bondholders
Disadvantages: have to pay interest pmts each period; single large pmt at maturity
Indenture specifies details of bond offering
Covenants limit companys future actions, protects interests of creditors