inven_wbn_outs_st01 Title page Inventories» What's Behind the Numbers?»» Cost Outflows» Scenic Video

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1 Title page Inventories» What's Behind the Numbers?»» Cost Outflows» Scenic Video

2 Agenda IFRS and US GAAP Introduction Cost methods Permissible IFRS methods Measurement Perpetual systems Periodic systems US GAAP Measurement LIFO Entries LIFO and FIFO pretax income LIFO tax savings Outsiders What do they see? What can they derive? Company disclosures Caterpillar LIFO reserve and LIFO and FIFO inventories LIFO and FIFO income statements IFRS and US GAAP Take-aways

3 Introduction: cost methods definition Definition Cost methods determine how cost inflows associated with purchasing or producing inventories are assigned to cost of goods sold.

4 Introduction: common cost methods

5 Introduction: Permissible IFRS cost methods

6 Measurement: perpetual inventory system defining feature

7 Measurement: periodic inventory system defining feature

8 FIFO perpetual versus periodic

9 Weighted average perpetual versus periodic

10 US GAAP: Measurement: LIFO perpetual versus periodic

11 US GAAP: Measurement: LIFO layers insider uses layers to get from FIFO to LIFO

12 US GAAP: Entries: Determining measures to be recorded

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14 US GAAP: Entries: BSE

15 US GAAP: Income before taxes: LIFO versus FIFO

16 US GAAP: LIFO tax savings

17 US GAAP: Outsiders: What insider information do outsiders see?

18 US GAAP: Outsiders: What can outsiders determine?

19 US GAAP: Caterpillar: LIFO Reserve and LIFO and FIFO inventories

20 US GAAP: FIFO and LIFO income statements

21 US GAAP: Caterpillar: Cumulative LIFO Tax Savings

22 Take-aways What should you know? IFRS and US GAAP Perpetual and periodic inventory systems are two ways to record the cost of sold goods to inventories: In perpetual systems, cost of sales is updated each time there is a sale. In periodic systems, cost of sales is updated at the end of each reporting period. FIFO cost of sales and ending inventories is the same under perpetual and periodic systems because the FIFO ordering is not affected by updating cost of sales during the period. Weighted average cost of sales and ending inventories generally do differ for perpetual and periodic systems because weighted average costs are affected by updating cost of sales. US GAAP LIFO cost of sales and ending inventories generally do differ for perpetual and periodic systems because LIFO orderings are affected by updating cost of sales. Differences in LIFO cost of sales and inventories between perpetual and periodic systems are likely considerably smaller for most companies than differences between LIFO and FIFO cost of sales and inventories. LIFO layers are the building blocks behind LIFO inventories: New LIFO layers are added to inventories during periods when companies acquire or produce more units than they sell. Old LIFO layers are eliminated (liquidated or decremented) during periods when companies sell more units than they acquire or produce. Older LIFO layers have lower unit costs when input prices are increasing and these layers can stay in inventories indefinitely. As a result, LIFO inventories can be valued much lower than they would be at replacement costs.

23 LIFO reserves connect LIFO and FIFO measures at balance sheet dates: FIFO inventory equals LIFO inventory plus the LIFO reserve Cumulative FIFO pretax income to date equals cumulative LIFO pretax income plus the LIFO reserve Cumulative FIFO tax expense to date equals cumulative LIFO tax expense plus the tax rate multiplied by the LIFO reserve Cumulative FIFO net income to date equals cumulative LIFO net income plus the LIFO reserve multiplied by one minus the tax rate FIFO retained earnings equals LIFO retained earnings plus the LIFO reserve multiplied by one minus the tax rate Cumulative LIFO tax savings to date equals the LIFO reserve multiplied by the tax rate The increase in the LFO reserve during a reporting period connects LIFO and FIFO period measures: FIFO cost of sales equals LIFO cost of sales less the increase in the LIFO reserve FIFO gross margin equals LIFO gross margin plus the increase in the LIFO reserve FIFO pretax income equals LIFO pretax income plus the increase in the LIFO reserve FIFO tax expense equals LIFO tax expense plus the increase in the LIFO reserve multiplied by the tax rate FIFO net income equals LIFO net income plus the increase in the LIFO reserve multiplied by one minus the tax rate

24 Take-aways Where are we heading? IFRS and US GAAP The other scenic routes in this module examine the measurement and record keeping issues behind two topics often discussed in companies footnotes: The income consequences of liquidating LIFO layers (US GAAP only) The income statement and balance sheet consequences of inventory impairments based on the lower of cost or market valuation rule. The How Do You Use the Numbers module demonstrates how the concepts in this module facilitate comparisons across LIFO and FIFO companies. We will be adding modules in the future that will examine inventory issues we overlooked here to simplify the discussion: In the Ran Sui s Trendy Tops (RSTT) example, we assume the number of units in ending inventory is known precisely and equals the beginning units plus units purchased during the period less units sold. In practice, other factors such as theft and deterioration affect the actual number of units in ending inventories. Companies frequently conduct physical counts to determine the precise units at the count date. When physical counts are too costly or not possible, companies can estimate cost of sales and thus ending inventory using either the retail method or gross profit method, which will be discussed in a future module. US GAAP RSTT had one product, which may have led you to incorrectly conclude companies perform separate LIFO and FIFO derivations for each product. Instead, they combine similar products into pools and use average input prices to estimate unit costs. The dollar-value-lifo method, which will be discussed in future modules, treats inventory as quantities of value rather than quantities of units and forms pools according to comparable economic characteristics rather than comparable physical characteristics. IFRS and US GAAP Learning these refinements will enhance your understanding of inventory disclosures. Still, the concepts covered here are all you need to know to interpret them in broad terms and to adjust measures so they are comparable across companies.