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Unformatted text preview: Investment Tools: Financial Statement Analysis: Assets 1.A: Analysis of Inventories a: Compute ending inventory balances and cost of goods sold using the LIFO, FIFO, and average cost methods to account for product inventory. Example: Given the following inventory data: January 1 (beginning inventory): 2 units @ $2 per unit = $ 4 January 7 purchase: 3 units @ $3 per unit = $9 January 19 purchase: 5 units @ $5 per unit = $25 Cost of goods available (BI + P): 10 units = $38 Units sold during January: 7 units FIFO cost of goods sold (value the 7 units sold at unit cost of last units purchased). Start at the top and work down: From beginning inventory: 2 units @ $2 per unit = $4 From first purchase: 3 units @ $3 per unit = $ 9 From second purchase: 2 units @ $5 per unit = $10 FIFO cost of goods sold: 7 units = $23 Ending inventory: 3 units @ $5 = $15 LIFO cost of goods sold (value the 7 units sold at unit cost of first units purchased). Start at the bottom and work up: From second purchase: 5 units @ $5 per unit = $25 From first purchase: 2 units @ $3 per unit = $6 LIFO cost of goods sold: 7 units = $31 Ending inventory: 2 @ $2 + 1 @ $3 = $7 Average cost of goods sold (value the 7 units sold at the average unit cost of goods available). Average unit cost = $38 / 10 = $3.80 per unit Weighted average cost of goods sold = 7 @ $3.80 = $26.60 Ending inventory = 3 @ $3.80 = $11.40 b: Explain the usefulness of inventory and cost-of-goods-sold data provided by the LIFO, FIFO, and average cost methods when prices are 1) stable, or 2) rising. Balance sheet : Inventories based on FIFO are preferable since these values most closely resemble current cost and hence current economic value. GAAP requires that firms use the lower of cost or market when valuing inventory. Applying the lower-of-cost-or-market to the inventory calculated under any cost flow assumption would decrease income and inventory on the balance sheet if market is lower than cost . If assigned costs to ending inventory using one of the cost flow assumptions (LIFO, FIFO, or average cost) is greater than the replacement market cost of that inventory, then that ending inventory must be written-down to market. This rule is applied individually to each major classification of inventory. Inventory is not changed if market price is greater than cost. This potentially increases cost of goods sold and decreases net income and current assets. Income statement : LIFO allocates the most recent prices to the cost of goods sold. For income statement purposes, LIFO is the most informative accounting method and provides a better measure of current income. The quandary, FIFO provides the best balance sheet measure and LIFO the best income statement measure. From an analyst's perspective there is often information available to permit restatement of one method to another to provide a better analysis. The discussion above assumes the value for purchases is known but this too may be affected by management choice....
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- Fall '08