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chapsummery9 - Chapter 09 Inventories CHAPTER 9 INVENTORIES...

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Chapter 09 - Inventories CHAPTER 9 INVENTORIES CHAPTER OVERVIEW Financial reporting rules allow a company latitude in selecting a cost flow assumption for the purpose of determining the cost of goods sold reported on the income statement and the inventory values reported on the balance sheet. Some of these firms use first in, first out (FIFO), some use last in, first out (LIFO), and some use weighted average; others use a combination of these methods. This diversity in practice can severely hinder both interfirm and intrafirm comparability when inventory purchase costs are change over time. Transfer pricing issues distort valuation when management tries to manipulate costs as they relate to local, state, and national tax rates. Outsourcing between related parties may also distort the financial picture because of pricing issues between related parties. The method of inventory valuation in the United States must be consistent with tax inventory valuation causing management to weigh tax versus book profits in their inventory decisions. FIFO gross margins may embed sizeable inventory holding gains, which may not be sustainable without continued inventory price increases. Similarly, LIFO gross margins can be distorted when LIFO liquidations occur. Working capital ratios and inventory turnover ratios of economically similar companies can look quite different under LIFO versus FIFO inventory costing. Users of financial statements must understand these differences and know how to adjust for them using various footnote disclosures. Only by doing so can valid comparisons be made across firms that utilize different cost flow assumptions. This chapter is designed to allow users to understand existing GAAP inventory methods and disclosures; it can also help users conduct informed comparisons and analysis of profitability and net asset positions across firms with varying inventory methods. 9-1
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Chapter 09 - Inventories CHAPTER OUTLINE I. An Overview of Inventory Accounting Issues A. Inventories are assets held for sale. 1. A manufacturing firm makes a final product from different inputs. a. Raw materials inventory consists of components that will eventually be used in the completed product. b. Work-in-process inventory contains the aggregate cost of units that have been started, but not completed at the balance sheet date. c. Finished goods inventory represents the total costs incorporated in completed, but unsold units. 2. Inventories are usually a significant asset, both in absolute size and in proportion to all other assets. 3. Selling inventory for a price greater than its cost represents the main source of a firm’s total long-run income. B. Retail example: 1. Important facts: a. Retailer started the year with a beginning inventory of one refrigerator that cost $300.
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