ACCT Session 14
LIFO carrying value
= LIFO inventory value
LIFO Liquidation
A LIFO liquidation results when inventory quantities decline for a firm using the LIFO method. A decline in inventories under LIFO cause older inventory costs to be matched with current selling prices. And, the result is in inflated or illusory profits margins LIFO liquidation profit is calculated as (Current Cost -LIFO layer cost) x Quantity Liquidated. When LIFO liquidation profits are material, the SEC requires that that the firm report the effect of the liquidation on the reported income for the period.
Q5: Ybarra Corp began operations in 2020. During its first year, the company purchased raw materials costing $84,000 and used $63,000 of those materials in the production of its products. The company's manufacturing operations also incurred labor costs of $58,000 and overhead costs of $28,000. At year end 2020, Ybarra had $19,000 of partially completed products in work-in-process inventory and $35,000 in finished goods inventory. What is the ending raw material inventory balance?
A: 21,000 84 - 63 K
Q4: Which of the following is not normally reported as part of total manufacturing inventory cost? A.Work-in-process. B.Raw materials. C.Finished goods. D.PPE.
A: PPE Manufacturing inventory has three categories -- work-in-process, raw materials, and finished goods PPE is a fixed asset, separate section of balance sheet ***depreciation of PPE related to production WILL be related to manufacturing inventory cost, not PPE itself
Q2: LIFO liquidation profits occur when
-Costs are rising and inventory quantity declines -We need this so that the older inventory has lower cost and more recent inventory has higher cost -Inventory quantity declines because firm is selling more inventory than it purchases
Manufacturing Inventory Costs Example Analysis
14,000 → cost of goods available for sale, and then 10,500 is cost of goods sold Transfer 10,500 to cost of goods sold and then we have additional depreciation of administration PPE (this is recorded after, NOT part of work in process) → have to record this 1k as selling and admin expenses, debit expenses and credit accumulated depreciation Then also have to account for wages for sales staff → credit wages payable and debit selling and admin expenses
Q3: Suppose the firm has 200 units of inventory at $100 each at the beginning of the year, purchases 500 units at $200 each during the year, and sells 600 units at $250. What is the LIFO liquidation profit?
A: 10,000 First thing to notice, will there be liquidation profit? -Yes, because prices are increasing!! -Also, firm sells 600 units, which is more than it purchased → difference in 100 units, thus meaning you have to go back to older layers of inventory How to compute? -First, what is the quantity liquidated? In this case, 100 (600-500) -Quantity liquidated → diff between what you sold and what you purchased -Current cost of LIFO → 200 dollar because that is the most recent purchase -100 → LIFlO layer cost
Q1: (pt II) If the firm had used FIFO to account for its inventory, its 2020 gross profit would be what?
A: 25 million
Q8: Ybarra Corp began operations in 2020. During its first year, the company purchased raw materials costing $84,000 and used $63,000 of those materials in the production of its products. The company's manufacturing operations also incurred labor costs of $58,000 and overhead costs of $28,000. At year end 2020, Ybarra had $19,000 of partially completed products in work-in-process inventory and $35,000 in finished goods inventory. What is the cost of goods sold?
A: 95K 130K - ____ = 35K Beginning finished goods inventory → ending inventory is 35,000, and cost of goods produced is 130K from last question
Q6: Ybarra Corp began operations in 2020. During its first year, the company purchased raw materials costing $84,000 and used $63,000 of those materials in the production of its products. The company's manufacturing operations also incurred labor costs of $58,000 and overhead costs of $28,000. At year end 2020, Ybarra had $19,000 of partially completed products in work-in-process inventory and $35,000 in finished goods inventory. What is the total amount debited to work-in-process inventory?
A: debit material costs, labor costs, and overhead cost → 63 + 58 + 28 = 149K
The value of the inventory on the FIFO basis approximates current cost. Why?
Because the cost of the inventory under FIFO is based on the cost of the more recent (relative to the end of the year) purchases, and, the cost of those more recent purchases are more representative of the current (end of year) cost.
Principles of conservatism
Conservatism → anticipate losses but do not recognize gain!! Only recognize gain once they are realized, i.e. when we sell inventory If, after the write-down, the inventory's market values rises, the firm CAN NOT adjust the carrying value of that inventory upward (i.e. recognize a gain) -Principle of conservatism Recognize losses when anticipatedbut recognize gains only when realized i.e. recognize gains only when the inventory is sold
Q7: Ybarra Corp began operations in 2020. During its first year, the company purchased raw materials costing $84,000 and used $63,000 of those materials in the production of its products. The company's manufacturing operations also incurred labor costs of $58,000 and overhead costs of $28,000. At year end 2020, Ybarra had $19,000 of partially completed products in work-in-process inventory and $35,000 in finished goods inventory. What is the cost of goods produced?
Cost of goods produced → Beginning work in process then we are debiting some amount to work in process (those costs) and then we are subtracting cost of goods produced to then find final work-in process inventory 149K - ____ = 19K A: 130 thousand Cost of goods produced → completed production materials
Work-In-Process Inventory
Costs incurred in the manufacturing process, to produce goods for sale, are capitalizedas a cost of Work-in-Process Inventory when they are incurred. These costs include: -Cost of raw materials used -Direct labor costs -Depreciation of manufacturing-related equipment -Utilities and other costs related to manufacturing
Example overhead cost
Depreciation
**Refer to snap-on case study in slides What would the cost of goods sold have been in fiscal 2013 if Snap-On had always used FIFO rather than the LIFO method to account for its inventory?
If FIFO Inventory value is larger than LIFO inventory value → indicates that prices are increasing
The Lower of Cost or Market (LCM) Requirement
If the current market value of the inventory is less than its historical cost, then the firm must adjust the carrying value of the inventory from historical cost to the lower market value. -"Market" value means net realizable value (NRV) NRV = Selling Price -Selling Costs Carrying value = historical cost If market value is lower than historical cost, then you need to write down the inventory "Market" → value that firm would get by selling the inventory -Market value = net realizable value
Exxon Mobile liquidation example
In the box → taking the LIFO reserve and adding LIFO inventory to find out FIFO inventory Exxon Mobil → uses LIFO to then have lower taxable income, can avoid taxes because it uses LIFO Inventory has accumulated over time, when Exxon Mobil reduces its inventory it uses its old inventory which has lower cost, leading to extra gain
Cost of Goods Sold
It is only when the goods are sold and delivered to the customer that the costs of producing them are expensed as the Cost of Goods Sold(when the inventories are removed from the Finished Goods inventory account).
LIFO Reserve
LIFO Reserve = FIFO Inventory -LIFO Inventory The difference between the FIFO cost and the LIFO cost of inventory Firms that use LIFO are required to disclose the LIFO reserve -Information about the LIFO reserve can be used to compare the reported financial statements (based on the use of LIFO) with those that would have been reported if the firm had used FIFO
Example: On December 31, ABC Company, using the FIFO method, determined that the cost of its inventory was $40,000. However, the current estimated net realizable value of those goods was $35,000. In order to adjust the carrying value of its inventory to the current market value (net realizable value), ABC must make the following entry:
Loss on inventory write-down → debit loss on inventory write-down and then credit inventory allowance/inventory (both work, but inventory allowance makes more sense) US GAAP does not allow firms to reverse on a write-down → allowance will thus eventually be transferred to inventory, not a big deal whether you credit inventory allowance or credit inventory, saying 'inventory allowance' is just more informative
Manufacturing Inventory Costs
Manufacturing firms have 3 categories of inventory: 1.Raw Materials 2.Work in Process 3.Finished Goods Inventory costs include expenditures and other charges (including depreciation) incurred in production to bring the inventory to its sellable condition and location.
Manufactured vs. merchandise inventory
Merchandise company → just has finished goods
What would the net earnings have been in fiscal 2013 if Snap-On had always used FIFO rather than the LIFO method? Assume a marginal tax rate of 35
Net earnings is always after tax → that's why we have to multiply change in LIFO Reserve by 1-t
Production vs. administrative PPE
Production PPE → conveyer belt, machines used to produce product Administrative PPE → company's headquarters and offices
Suppose that Snap-On Tools had always used the FIFO basis. By what amount would the firm's 2013 Retained Earnings balance at the end of fiscal 2013 increase or decrease? Assume that the tax rate (t) of 35% is applicable over the firm's entire life.
Retained earnings → we know LIFO reserve is cumulative difference between FIFO and LIFO COGS Thus, we know that the diff in retained earnings is just going to be this LIFO reserve number, its ending balance Retained earnings is also after tax → have to multiply LIFO reserve number by (1-t) Adding back LIFO reserve to get the FIFO inventory Extra taxes under FIFO -- higher by LIFO reserve times the tax rate Dont acc have to calculate income taxes payable for this problem, this is just showing where taxes are accounted for Retained earnings → cumulative sum of net income after tax Change in LIFO reserve = difference in net income,
Finished Goods
Subsequently, those costs are transferred (from Work-in-Process inventory) to the Finished Goods inventory as production is completed and the goods become available for sale.
Assuming a marginal tax rate of 35%, determine the tax saving from using the LIFO method rather than the FIFO method:
Tax saving arises because LIFO net income is lower than FIFO net income For one year of tax saving -- change in LIFO reserve x tax rate For the life of the firm, have to add up all those change in LIFO reserves, which is the ending LIFO reserve, which then you have to multiply by tax rate
LIFO Liquidation re-explained
Telling us that profits under LIFO are going to be very high -- taking very old inventory costs and allocating those to COGS
Aggregate replacement cost of inventory
This is also going to be equal to the FIFO inventory, because FIFO inventory will have most recent prices so it will approximate replacement cost -- what firm would get if it were to replace inventory today
Adjusting from LIFO to FIFO
To compare firms that use different methods, recompute the financial statements of a LIFO firm as if it had used FIFO for all of its inventories LIFO Reserve -The difference between a company's inventory valued at FIFO minus what it would have been under LIFO -Represents the cumulative difference in COGS over the time for a company that uses LIFO relative to what it would have been under FIFO Change in LIFO Reserve represents the difference in COGS for a given year for a company that uses LIFO relative to what it would have been under FIFO
Snap-on Case Study Overview
Used LIFO, thus have to disclose their LIFO reserve "Excess of current cost over LIFO cost" = LIFO reserve e -Even though its negative in the sheet it's actually a positive number LIFO reserve = difference in FICO inventory value and LIFO inventory value "Total inventories net" -- inventory value under LIFO
Capitalization
When the cost incurred by the firm is not expensed immediately but is included in the value of an asset When firm purchases PPE, not expensing it right away → debiting PPE and over time it is depreciating it Basically debiting asset instead of recording an expense
Recording...
#1: Raw materials Transfer it to work in process inventory → credit raw material, debit work in process #2: Production PPE Record accumulated depreciation, credit accumulated depreciation and debit work in process #3: Wages of personnel Have to capitalize as work in process by debiting work in process and then crediting wages payable
