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7 terms
abrllc

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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