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*** Adult Truths *** - An Email Forward

*** Adult Truths *** - An Email Forward. You never know when it will strike, but there comes a moment at work when you know that you just aren't going to do anything productive for the rest of the day.

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*** Adult Truths *** - An Email Forward

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  1. *** Adult Truths *** - An Email Forward • You never know when it will strike, but there comes a moment at work when you know that you just aren't going to do anything productive for the rest of the day. • Can we all just agree to ignore whatever comes after Blue Ray? I don't want to have to restart my collection...again. • I'm always slightly terrified when I exit out of Word and it asks me if I want to save any changes to my ten-page technical report that I swear I did not make any changes to. • I think the freezer deserves a light as well. • I keep some people's phone numbers in my phone just so I know not to answer when they call. • I disagree with Kay Jewelers. I would bet on any given Friday or Saturday night more kisses begin with beer than Kay. • I wish Google Maps had an "Avoid Ghetto" routing option. • I have a hard time deciphering the fine line between boredom and hunger.

  2. Class on Monday • 8:00 351M 24 seats? • 9:30 351M 6 seats? • 11:00 351M 5 seats? • 2:00 250M 26 seats? • 3:30 No class Also, KPMG case competition info

  3. Chapter 8CONTINUED VALUATION OF INVENTORIES: A COST-BASIS APPROACHSommers – ACCT 3311

  4. Discussion Question Explain why proponents of LIFO argue that it provides a better match of revenue and expenses. In what situation would it not provide a better match? Proponents of LIFO argue that it provides a better match of revenues and expenses because cost of goods sold includes the costs of the most recent purchases. These are matched with sales that reflect a current selling price. On the other hand, inventory costs in the balance sheet generally are out of date because they are derived from old purchase transactions. It is conceivable that a company’s LIFO inventory balance could be based on unit costs actually incurred several years earlier. When inventory quantity declines during a period, then these out-of-date inventory layers will be liquidated and cost of goods sold will match noncurrent costs with current selling prices.

  5. Discussion Questions Q8–18 Explain the following terms: (a) LIFO Layer A LIFO layer (increment) is formed when the ending inventory at base-year prices exceeds the beginning inventory at base-year prices. (b) LIFO Reserve The difference between the inventory method used for internal purposes and LIFO. (c) LIFO Effect The change in the LIFO reserve (Allowance to Reduce Inventory to LIFO) from one period to the next.

  6. Simplifying LIFO with LIFO Inventory Pools • The objectives of using LIFO inventory pools are to simplify recordkeeping by grouping inventory units into pools based on physical similarities of the individual units and to reduce the risk of LIFO layer liquidation. • For example, a glass company might group its various grades of window glass into a single window pool. Other pools might be auto glass and sliding door glass. A lumber company might pool its inventory into hardwood, framing lumber, paneling, and so on. • LIFO pools allow companies to account for a few inventory pools rather than every specific type of inventory separately.

  7. Dollar Value LIFO (DVL) • DVL extends the concept of inventory pools by allowing a company to combine a large variety of goods into one pool. Physical units are not used in calculating ending inventory. The technique helps companies simplify LIFO record-keeping, it also minimizes the probability of layer liquidation. At the end of the period, we determine if a new inventory layer was added by comparing ending inventory to beginning inventory. When using DVL we think in terms of inventory layers rather than inventory pools. • The goal of DVL is to determine if an increase in ending inventory over beginning inventory is due to a price increase of a real increase in inventory.

  8. Dollar-Value LIFO (DVL) 1a. Compute a Cost Index for the year. 1b. Deflate the ending inventory value using the cost index. 1c. Compare ending inventory (at base year cost) to beginning inventory.

  9. Dollar-Value LIFO (DVL) • Next, identify the layers in ending inventory and the years they were created. • Convert each layer’s base year cost to layer year cost by multiplying times the cost index. • Sum all the layers to arrive at Ending Inventory at DVL cost. You are totally lost so let’s do this!

  10. Example 2: Dollar Value LIFO Method On January 1, 2011, the Taylor Company adopted the dollar-value LIFO method. The inventory value for its one inventory pool on this date was $400,000. Inventory data for 2011 through 2013 are as follows: Calculate Taylor’s ending inventory for 2011, 2012, and 2013.

  11. Example 2: Continued On January 1, 2011, the Taylor Company adopted the dollar-value LIFO method. The inventory value for its one inventory pool on this date was $400,000. Inventory data for 2011 is as follows: Calculate Taylor’s ending inventory for 2011.

  12. Example 2: Continued Adjust 2011 inventory to 2010 base-year prices: $441,000 / 1.05 = $420,000 Calculate current year LIFO layer: $420,000 – $400,000 = $20,000 Add the new LIFO layer at end of period prices to prior year LIFO inventory: $400,000 * 1.00 = $400,000 20,000 * 1.05 = 21,000 $421,000

  13. Example 2: Continued On January 1, 2011, the Taylor Company adopted the dollar-value LIFO method. The inventory value for its one inventory pool on this date was $400,000. Inventory data for 2011 through 2012 are as follows: Calculate Taylor’s ending inventory for 2012.

  14. Example 2: Continued Adjust 2012 inventory to 2010 base-year prices: $487,200 / 1.12 = $435,000 Calculate current year LIFO layer: $435,000 – $420,000 = $15,000 Add the new LIFO layer at end of period prices to prior year LIFO inventory: $400,000 * 1.00 = $400,000 20,000 * 1.05 = 21,000 15,000 * 1.12 = 16,800 $437,800

  15. Example 2: Continued On January 1, 2011, the Taylor Company adopted the dollar-value LIFO method. The inventory value for its one inventory pool on this date was $400,000. Inventory data for 2011 through 2013 are as follows: Calculate Taylor’s ending inventory for 2013.

  16. Example 2: Continued Adjust 2013 inventory to 2010 base-year prices: $510,000 / 1.20 = $425,000 Calculate current year LIFO layer: $425,000 – $435,000 = ($10,000) Layer liquidation Calculate LIFO layers at end of period prices: $400,000 * 1.00 = $400,000 20,000 * 1.05 = 21,000 5,000 * 1.12 = 5,600 $426,600

  17. LIFO Liquidation Older, low cost inventory is sold resulting in a lower cost of goods sold, higher net income, and higher taxes. • Basler Co. has 30,000 pounds of steel in its inventory on December 31, 2012, with cost determined on a specific-goods LIFO approach.

  18. LIFO Liquidation Example Continued At the end of 2013, only 6,000 pounds of steel remained in inventory.

  19. LIFO Liquidation When prices rise ... • LIFO inventory costs in the balance sheet are “out of date” because they reflect old purchase transactions. • If inventory declines, these “out of date” costs may be charged to current earnings. • This LIFO liquidation results in “paper profits.” Could this be a source of abuse?

  20. Example 3: LIFO Liquidation The Reuschel Company began 2011 with inventory of 10,000 units at a cost of $7 per unit. During 2011, 55,000 units were purchased for $8.50 each. Sales for the year totaled 54,000 units leaving 11,000 units on hand at the end of 2011. Reuschel uses a periodic inventory system and the LIFO inventory cost method. Calculate cost of goods sold for 2011. Cost of goods sold: • 54,000 units x $8.50 = $459,000

  21. Example 3: LIFO Liquidation Continued The Reuschel Company began 2011 with inventory of 10,000 units at a cost of $7 per unit. During 2011, 50,000 units were purchased for $8.50 each. Sales for the year totaled 54,000 units leaving 6,000units on hand at the end of 2011. Reuschel uses a periodic inventory system and the LIFO inventory cost method. Calculate cost of goods sold for 2011. Cost of goods sold: • 50,000 units x $8.50 = $425,0004,000 units x $7.00 = 28,000 $453,000 COGS is $6,000 lower because we did not buy inventory!

  22. Example 3: LIFO Liquidation Continued From a financial reporting perspective, what problem is created by the use of LIFO in this situation? Describe the disclosure required to report the effects of this problem. When inventory quantity declines during a period, liquidation of LIFO inventory layers carried at lower costs prevailing in prior years results in noncurrent costs being matched with current selling prices. If the resulting effect on income is material, it must be disclosed. In this case, the effect of the LIFO layer liquidation is to increase income (ignoring taxes) by $6,000 [4,000 units liquidated x $1.50 ($8.50 current year cost per unit - $7 LIFO layer cost per unit)].

  23. Decision Makers’ Perspective Factors Influencing Method Choice • How closely do reported costs reflect actual flow of inventory? • How well are costs matched against related revenues? • How are income taxes affected by inventory method choice?

  24. LIFO Disadvantages Advantages • Matching • Tax Benefits/Improved Cash Flow • Future Earnings Hedge • Reduced Earnings • Inventory Understated • Physical Flow • Involuntary Liquidation / Poor Buying Habits

  25. Basis for Selection of Inventory Method • LIFO is generally preferred: • if selling prices are increasing faster than costs and • if a company has a fairly constant “base stock.” • LIFO is not appropriate: • if prices tend to lag behind costs, • if specific identification traditionally used, and • when unit costs tend to decrease as production increases.

  26. LIFO Matches high (newer) costs with current (higher) sales. Inventory is valued based on low (older) cost basis. Results in lower taxable income. FIFO Matches low (older) costs with current (higher) sales. Inventory is valued at approximate replacement cost. Results in higher taxable income. When Prices Are Rising . . .

  27. Example 1: Summary of Results Costs were rising. If costs are falling, ordering is opposite.

  28. Quality of Earnings Changes in the ratios we have discussed often provide information about the quality of a company’s current period earnings. For example, a slowing turnover ratio combined with higher than normal inventory levels may indicate the potential for decreased production, obsolete inventory, or a need to decrease prices to sell inventory (which will then decrease gross profit ratios and net income). Many believe that manipulating income reduces earnings quality because it can mask permanent earnings. Inventory write-downs and changes in inventory method are two additional inventory-related techniques a company could use to manipulate earnings.

  29. E8-24 The dollar-value LIFO method was adopted by Enya Corp. on January 1, 2014. Its inventory on that date was $160,000. On December 31, 2014, the inventory at prices existing on that date amounted to $140,000. The price level at January 1, 2014, was 100, and the price level at December 31, 2014, was 112. • Compute the amount of the inventory at December 31, 2014, under the dollar-value LIFO method. • On December 31, 2015, the inventory at prices existing on that date was $172,500, and the price level was 115. Compute the inventory on that date under the dollar-value LIFO method.

  30. E8-24 a. Adjust 2014 inventory to 2013 base-year prices: $140,000 / 1.12 = $125,000 Calculate current year LIFO layer: $125,000 – $160,000 = ($35,000) Layer liquidation Calculate LIFO layers at end of period prices: $125,000 * 1.00 = $125,000

  31. E8-24 b. Adjust 2015 inventory to 2013 base-year prices: $172,500 / 1.15 = $150,000 Calculate current year LIFO layer: $150,000 – $125,000 = $25,000 Layer Calculate LIFO layers at end of period prices: $125,000 * 1.00 = $125,000 25,000 * 1.15 = 28,750 $153,750

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