Review the posts of your peers, and respond to at least two. For each response, address any discrepancies between your findings and your peer's. Seek clarification of any aspects of the post that are not clear to you.
Student 1
As a chief financial officer, the accounting principle of lower cost or market is an asset and economic resource where the inventory is valued at the lower of historical cost or current replacement. For the income statement, the LCM (lower cost market) rule can be used with any cost flow assumption, also as the basis of inventory items, a category or as individual inventory items. Associating inventory with the cost of good on the income statement is what the company pays to buy or manufacture the goods it sells to the customer in that particular period. As the rest of the cost of product purchases stays on the balance sheets as a current asset. First in and first out (FIFO) is the cost of earliest purchases on hand at the time of the sale and the inventory of the cost of most recently purchased units. This method can overstate the income and increase the income taxes that are due. In contrast the Last in, first out (LIFO) is the cost of the most recently purchased units and the cost of the inventory that is purchased the earliest, making this the most conservative method as it uses the most recent prices of goods sold.
If a company changed the inventory method, the balance sheet measurements would be affected as the figures in the cost of goods sold, gross profit and net income can have changed the valuation, creating a possible error in the financial statements. Therefore yes, the inventory rate is not the only ratio affected. The Chief Financial officer should have notes in the financial statements that provide the necessary information when changing operating valuation methods.
The ratios of inventory turnover and days to sell inventory indicate to the financial statement users the effectiveness of inventory management. It is figured by inventory divided by the cost of sales multiplied by 365 (days of the year). The turnover is figured by the cost of goods sold or sales divided by the average inventory. The higher the inventory rate the better it looks for the company because it shows a greater generation of sales. The days to sell inventory is a similar calculation as it uses 1 divided by the inventory turnover multiplied by 365, showing a more accurate figure on the daily inventory management. Users of the financial statements find the inventory turnover rate useful in evaluating the liquidity if the organizations inventory, and can identify what is selling and what is not. The inventory rates can also be used in comparing with competitors so it is key to find a balance between optimal inventory levels and market demands.
References
Day sales of inventory-Williams, J., Haka, S., Better, M., & Carcello, J. (2006). Financial accounting (12th ed.). New York, NY: McGraw-Hill/Irwin.
Student 2
What do the ratios inventory turnover and days to sell inventory indicate to the financial statement users? The inventory turnover ratio reflects how many times average inventory was produced and sold during the period. A sudden decline inventory turnover ratio may mean that a company is facing an unexpected drop in demand for its products or is becoming sloppy in its production management. The average number of days to sell indicates the average time the company takes to produce and deliver inventory to customers. A higher ratio indicates that inventory moves more quickly through the production process to the ultimate customer, reducing storage and obsolescence costs (Libby, 2013). The days' sales in inventory tells you the average number of days that it took to sell the average inventory held during the specified one-year period. You can also think of it as the number of days of sales that was held in inventory during the specified year. The calculation of the days' sales in inventory is: the number of days in a year (365 days) divided by the inventory turnover ratio. The selected inventory method used should also be stated. The factors, criteria and utilized methods the company uses to determine inventories should be stated as well. There would also be a forecast of if the inventories are expected to increase or decrease as the company business continues (Libby, 2013).
Can an organization change its selected inventory method, and, if so, is there an effect on current net income or retained earnings? Why or why not? A company can use any of the inventory costing method. A company is not required to use the same inventory costing method for all inventory items, and no particular justification is needed for the selection of one or more of the acceptable methods. As noted in our text, Harley- Davidson, and most large companies, use different inventory methods for different inventory items. However, accounting rules require companies to apply their accounting methods on a consistent basis over time. A company is not permitted to use LIFO one period, FIFO the next, and then go back to LIFO. A change in method is allowed only if the change will improve the measurement of financial results and financial position (Libby, 2013).
Most managers choose accounting methods based on two factors: 1.Net income effects (managers prefer to report higher earnings for their companies). 2. Income tax effects (managers prefer to pay the least amount of taxes allowed by law as late as possible-the least-latest rule of thumb).
The selection of an inventory costing method is important because it will affect reported income, income tax expense (and hence cash flow), and the inventory valuation reported on the balance sheet. In a period of rising prices, FIFO normally results in a higher income and higher taxes than LIFO; in a period of falling prices, the opposite occurs. The choice of methods is normally made to minimize taxes.
Answer the following question to practice converting cost of goods sold and pretax income from the LIFO to the FIFO method for a company facing increasing prices (Libby, 2013).
How does net book value on fixed assets differ from fair market value of fixed assets, and how do they relate to liquidation?
The net amount on the balance sheet is called the net book value. The net book value of a long-lived asset is its acquisition cost less the accumulated depreciation from the acquisition date to the balance sheet date. The net book value is the value minus depreciation. The current market price or value is that an asset will sell for. They relate to liquidation due to their value as a tangible asset both fixed as well as current. They add value to a company if the company is going out of business (Vaidya, 2018).
References:
Libby, R., Libby, P., Short, D. (06/2013). Financial Accounting, 8th Edition. [Bookshelf Online].
Investment Banking: Financial Modeling Training Courses Online.