[Level 1] Revision Phase with SAPP

Buổi 10 - FRA - Reading 25: Inventories & Reanding 26: Long-lived assets

READING 25: INVENTORIES

LOS 25.a: distinguish between costs included in inventories and costs recognised as expenses in the period in which they are incurred.
Question 25.1:
 Inventory cost is most likely to include:
A) storage costs for finished goods until they are actually sold.
B) shipping cost for delivery to the customer.
C) an allocation of fixed production overhead.
Explanation
C is correct. An allocation of fixed production overhead based on normal production capacity is included in inventory cost. Neither storage costs that are not required as part of the production process nor shipping costs for delivery to the customer are included in inventory cost.
Schweser note: 
The costs included in inventory are similar under IFRS and U.S. GAAP. These costs, known
as product costs, are capitalized in the Inventories account on the balance sheet and include:
1. Purchase cost less trade discounts and rebates.
2. Conversion (manufacturing) costs including labor and overhead.
3. Other costs necessary to bring the inventory to its present location and condition.
Not all inventory costs are capitalized; some costs are expensed in the period incurred. These
costs, known as period costs, include:
1. Abnormal waste of materials, labor, or overhead.
2. Storage costs (unless required as part of production).
3. Administrative overhead.
4. Selling costs

LOS 25.b: Describe different inventory valuation methods (cost formulas).
Question 25.2: During a period of falling costs of manufacturing, which of the following inventory cost formulas would result in the greatest reported net income?
A) LIFO.
B) FIFO.
C) Average cost
Explanation
A is correct. With LIFO, more recent, lower costs would be used for COGS. A reduction in COGS will increase gross profits and net income, other things equal.

LOS 25.c: Calculate and compare cost of sales, gross profit, and ending inventory using different inventory valuation methods and using perpetual and periodic inventory systems.
Question 25.3: A firm uses the first-in first-out (FIFO) cost flow assumption. Compared to gross profit with a periodic inventory system, the firm's gross profit with a perpetual inventory system would be:
A) lower.
B) higher.
C) the same.
Explanation
C is correct. For a firm using FIFO, gross profit is the same whether the firm uses a periodic or perpetual inventory system. For a firm using LIFO or average cost, gross profit can be different depending on the choice of inventory system.
Schweser note:
In a periodic inventory system, inventory values and COGS are determined at the end of the accounting period.
In a perpetual inventory system, inventory values and COGS are updated continuously.
Inventory purchased and sold is recorded directly in inventory when the transactions occur.
Thus, a Purchases account is not necessary

LOS 25.d: Calculate and explain how inflation and deflation of inventory costs affect the financial statements and ratios of companies that use different inventory valuation methods
Question 25.4: From the point of view of a financial analyst, when evaluating companies that use different inventory cost assumptions, in a period of:
A) stable prices, LIFO inventory is preferred to FIFO inventory.
B) decreasing prices, FIFO inventory is preferred to LIFO inventory.
C) increasing prices, FIFO cost of sales is preferred to LIFO cost of sales.
Explanation
B is correct. The most useful estimates of inventory and cost of sales are those that best approximate current cost. Whether prices are increasing or decreasing, FIFO provides a better estimate of inventory values, and LIFO provides a better estimate of cost of sales. If prices are stable, there is no difference between LIFO and FIFO estimates of inventory or cost of sales.
Schweser note:
During deflationary periods and stable or increasing inventory quantities, the cost flow effects
of using LIFO and FIFO will be reversed; that is, LIFO COGS will be lower and LIFO
ending inventory will be higher. This makes sense because the most recent lower-cost
purchases are assumed to be sold first under LIFO, and the units in ending inventory are
assumed to be the earliest purchases with higher costs.

LOS 25.f: Convert a company’s reported financial statements from LIFO to FIFO for purposes of comparison
Question 25.5: A company using LIFO reports the following:
Cost of goods sold was                                                               $27,000.
Beginning inventory was $6,500, and ending inventory was        $6,200.
The beginning LIFO reserve was                                                  $1,200.
The ending LIFO reserve was                                                       $1,400.
The best estimate of the company's cost of goods sold on a FIFO basis would be:
A) $21,300.
B) $26,800.
C) $27,500.
Explanation
B is correct.
Step 1: Understand the question and find the right formula
COGS FIFO = COGS LIFO − (ending LIFO reserve − beginning LIFO reserve)
Step 2: Calculate COGS FIFO
COGS FIFO = 27,000 − (1,400 − 1,200) = $26,800.

Question 25.6: A firm ended the last period with inventory of $4.0 million and a LIFO reserve of $175,000. During the year, it made purchases of $2.0 million and reported sales of $5.5 million with a gross margin of 0.32. At the end of the year, it reported a LIFO reserve of $75,000. What is the value of the firm's cost of goods sold on a FIFO basis?
A) $3,640,000.
B) $3,740,000.
C) $3,840,000.
Explanation
C is correct.
Step 1: Understand the question and find the right formula
FIFO COGS = LIFO COGS − (ending LIFO reserve − beginning LIFO reserve)
Step 2: Calculate LIFO COGS
LIFO COGS = $5.5 million × (1 − 0.32) = $3.74 million
Step 3: Calculate FIFO COGS
FIFO COGS = $3,740,000 − ($75,000 − $175,000) = $3,840,000

LOS 25.g: Describe the measurement of inventory at the lower of cost and net realisable value
Question 25.7: Rowlin Corporation, which reports under IFRS, wrote down its inventory of electronic parts last period from its original cost of €28,000 to net realizable value of €25,000. This period, inventory at net realizable value has increased to €30,000. Rowlin should revalue this inventory to:
A) €28,000, and report a gain of €3,000 on the income statement.
B) €30,000, and report a gain of €3,000 on the income statement.
C) €30,000, and report a gain of €5,000 on the income statement.
Explanation
A is correct. Under IFRS, inventory values are revalued upward only to the extent they were previously written down. In this case, that is from €25,000 back up to the original value of €28,000. The increase is reported as gain for the period.
Schweser note: 
Net realizable value (NRV) is equal to the expected sales price less the estimated selling costs and completion costs. If net realizable value is less than the balance sheet value of inventory, the inventory is “written down” to net realizable value and the loss is recognized in the income statement. If there is a subsequent recovery in value, the inventory can be “written up” and the gain is recognized in the income statement by reducing COGS by the amount of the recovery.

LOS 25.k: Calculate and compare ratios of companies, including companies that use different inventory methods & LOS 25.l: Analyze and compare the financial statements of companies, including companies that use different inventory methods
Question 25.8: In periods of rising prices and stable or increasing inventory quantities, compared with companies that use LIFO inventory accounting, companies that use the FIFO method will have:
A) higher COGS and lower taxes.
B) higher net income and higher taxes.
C) lower inventory balances and lower working capital.
Explanation
B is correct. FIFO companies have higher net income, lower COGS, higher inventory, and higher taxes.

LOS 25.j: Explain issues that analysts should consider when examining a company’s inventory disclosures and other sources of information
Question 25.9: Data for a manufacturing industry indicate that inventories of work in progress are increasing faster than sales. This is most likely to indicate that:
A) the business cycle is at a peak.
B) inventory is becoming obsolete.
C) firms expect demand to increase
Explanation
C is correct. An increase in work-in-progress inventory relative to sales is likely to result from firms increasing production because they expect an increase in demand. An increase in finished goods inventories relative to sales would be more likely to indicate a decrease in demand that may be caused by obsolete inventory or a business cycle peak.

LOS 25.i: Describe the financial statement presentation of and disclosures relating to
inventories.
Question 25.10: A company that reports under U.S. GAAP and changes its inventory cost assumption from weighted average cost to last-in first-out is required to apply this change in accounting principle:
A) retrospectively, and disclose the new cost flow method being used.
B) prospectively, and explain the reasons for the change in the financial statement disclosures.
C) retrospectively, and explain the reasons for the change in the financial statement disclosures.
Explanation
B is correct. Under U.S. GAAP, a change to LIFO from another inventory cost method is an exception to the requirement of retrospective application of changes in an accounting principle. Instead of restating prior years' data, the firm uses the carrying value of inventory at the time of the change as the first LIFO layer. U.S. GAAP requires a company that is changing its inventory cost assumption to explain, in its financial statement disclosures, why the new method is preferable to the old method.

LOS 25.h: Describe implications of valuing inventory at net realisable value for financial statements and ratios.
Question 25.11: Greene Company discloses that its net income for the most recent period was reduced by a writedown of inventory to net realizable value. What effect is the inventory writedown most likely to have on Greene's net income in future periods?
A) Increase.
B) Decrease.
C) No effect.
Explanation
A is correct. In future periods, lower-valued inventory will result in lower cost of sales and higher net income.
Schweser note: 
Assuming the write-down is reported as part of the cost of sales, these effects in the period of the write-down include:
As inventory is part of current assets, an inventory write-down decreases both current and total assets.
Current ratio (CA/CL) decreases. However, the quick ratio is unaffected because
inventories are not included in the numerator of the quick ratio.
Inventory turnover (COGS/average inventory) is increased, which decreases days’ inventory on hand and the cash conversion cycle.
The decrease in total assets increases total asset turnover and increases the debt-toassets ratio.
Equity is decreased, increasing the debt-to-equity ratio.The increase in COGS reduces gross margin, operating margin, and net margin. The percentage decrease in net income can be expected to be greater than the percentage decrease assets or equity. As a result, both ROA and ROE are decreased.

READING 26: LONG-LIVED ASSETS

Question 26.1: Degen, Inc., owns a trademark which it originally valued at €15 million on its balance sheet but currently values at €10 million. In the country where Degen is incorporated, trademarks are protected by law for as long as their owner remains a going concern. Degen has most likely:
A) developed its trademark at a cost of €15 million.
B) recorded amortization expense of €5 million on its trademark.
C) recognized €5 million of impairment charges on its trademark.
Explanation
C is correct. The trademark is an intangible asset with an indefinite life, and its cost is not amortized. The decrease in the trademark's balance sheet value must be the result of impairment. For the intangible asset to appear on the balance sheet, Degen must have purchased the trademark. If Degen had developed the trademark internally, it would have expensed the cost rather than capitalizing it to the balance sheet.
(Reading 26, LOS 26.a,26.b,26.i)


LOS 26.b: Compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination

Question 26.2: Which of these intangible assets is most likely to be amortized?
A) Purchased patent that will expire in the current period.
B) Purchased franchise right with a useful life of two years.
C) Internally developed trademark with a useful life of 20 years.
Explanation
B is correct. A purchased, identifiable intangible asset with a finite life is amortized over its useful life. Costs incurred to develop an intangible asset such as a trademark are expensed when incurred. A patent that expires in the current period will not provide future benefits and therefore should not be recognized as an asset.
Schweser note:
Under IFRS, research costs, which are costs aimed at the discovery of new scientific or technical knowledge and understanding, are expensed as incurred. However, development costs may be capitalized.
Under U.S. GAAP, both research and development costs are generally expensed as incurred.
However, the costs of creating software for sale to others are treated in a manner similar to
the treatment of research and development costs under IFRS.
Like tangible assets, an intangible asset purchased from another party is initially recorded on
the balance sheet at cost, typically its fair value at acquisition.

LOS 26.c: Explain and evaluate how capitalising versus expensing costs in the period in which they are incurred affects financial statements and ratios.
Question 26.3: A company purchases an asset in the first quarter and decides to capitalize the asset. Compared to expensing the asset cost, capitalizing the asset cost will result in higher cash flows in the first quarter from:
A) investing.
B) financing.
C) operations.
Explanation
C is correct. Capitalizing the cost of the asset results in higher CFO and lower CFI in the period of the purchase, compared to expensing the entire cost. If the cost is expensed, the cash outflow is classified as CFO, but if the asset is capitalized, the cash outflow is classified as CFI. Cash flow from financing is not affected by the decision to capitalize.
Schweser note
A capitalized expenditure is usually reported in the cash flow statement as an outflow from
investing activities. If immediately expensed, the expenditure is reported as an outflow from
operating activities. Thus, capitalizing an expenditure will result in higher operating cash
flow and lower investing cash flow compared to expensing. Assuming no differences in tax
treatment, total cash flow will be the same.

Question 26.4: A company that capitalizes costs instead of expensing them will have:
A) higher income variability and higher cash flows from operations.
B) lower cash flows from investing and lower income variability.
C) lower cash flows from operations and higher profitability in early years.
Explanation
B is correct. Capitalizing costs tends to smooth earnings and reduces investment cash flows. It will also increase cash flows from operations and increase profitability in the early years.

LOS 26.d: describe the different depreciation methods for property, plant, and equipment and calculate depreciation expense.
Question 26.5: Novak, Inc. owns equipment with a historical cost of $20,000, a useful life of 5 years, and an estimated salvage value of $5,000. Using the double declining balance method, depreciation expense in Year 3 for this equipment is:
A) $2,200.00
B) $3,000.00
C) $2,880.00
Explanation
A is correct.
DDB depreciation in each year is 2/5 of the carrying value at the beginning of the year, until the carrying value reaches the estimated salvage value.
Year 1 DDB depreciation = $20,000 × 2/5 = $8,000
Carrying value = $20,000 – $8,000 = $12,000
Year 2 DDB depreciation = $12,000 × 2/5 = $4,800
Carrying value = $12,000 – $4,800 = $7,200
Year 3 DDB depreciation = $7,200 × 2/5 = $2,880
Because $7,200 – $2,880 = $4,320 would depreciate the equipment below its salvage value, depreciation in Year 3 is limited to $7,200 – $5,000 = $2,200

LOS 26.e: describe how the choice of depreciation method and assumptions concerning useful life and residual value affect depreciation expense, financial statements, and ratios.
Question 26.6: Accelerated depreciation methods for financial reporting are most likely to have which of the following effects on a company's financial ratios during the early years of an asset's life?
A) Higher asset turnover ratio.
B) Lower debt-to-equity ratio.
C) Lower current ratio.
Explanation
A is correct. Given the higher depreciation expense recorded in the early years under accelerated depreciation methods, total assets will be lower, causing a higher asset turnover ratio versus straight-line

LOS 26.f: Describe the different amortisation methods for intangible assets with finite lives and calculate amortisation expense.
Question 26.7: As a result of a recent acquisition, Lombard, Inc., has placed the following items on their balance sheet as of the beginning of their fiscal year:
Goodwill $30 million
Patent $10 million Expires in 10 years.
Trademark $15 million Expires in 15 years, renewable at minimal cost. If Lombard amortizes intangible assets using the straight line method, the amortization expense on these assets for the fiscal year will be:
A) $1 million.
B) $2 million.
C) $3 million
Explanation
A is correct. Goodwill has an indefinite life and is not amortized. A trademark or other intangible asset that has an expiration date but is renewable at minimal cost is treated as having an indefinite life and is not amortized. The patent has a finite life and its cost will be amortized at the rate of $1 million each year over ten years under the straight-line method.
Schweser note
Intangible assets with finite lives are amortized over their useful lives. Amortization is
identical to the depreciation of tangible assets. The same methods, straight-line, accelerated,
and units-of-production, are permitted. The calculation of amortization expense also requires
estimates of useful lives and salvage values

LOS 26.g: describe how the choice of amortisation method and assumptions concerning useful life and residual value affect amortisation expense, financial statements, and ratios; 26.h: describe the revaluation model & 26.l: describe the financial statement presentation of and disclosures relating to property, plant, and equipment and intangible assets. 
Question 26.8: Clement Company has revalued an intangible asset with an indefinite life upward by €25 million. In its financial statements, Clement will most likely:
A) disclose how it determined the fair value of the intangible asset.
B) report lower net income in subsequent periods because of increased amortization expense on the asset.
C) report higher assets, net income, and shareholders’ equity in the most recent period than it would have reported under the cost model.
Explanation
A is correct. For firms that revalue assets upward, IFRS requires disclosure of the date the asset was revalued, how management determined its fair value, the asset's carrying value using the historical cost model, and (for intangible assets) whether the asset's useful life is finite or indefinite. Although assets and shareholders' equity will increase as a result of the revaluation, net income will not increase. The increase in the value of the asset is reported as a revaluation surplus in shareholders' equity. Amortization expense will not increase because indefinite-lived intangible assets are not amortized.

LOS 26.h: describe the revaluation model.
Question 26.9: For a firm to use the revaluation model for balance sheet reporting of long-lived assets:
A) the firm must choose which assets of each type to revalue, and which to report at cost.
B) the firm must report under U.S. GAAP.
C) an active market must exist for the assets.
Explanation
Under IFRS, a firm may use the revaluation model for long-lived assets that have an active market which can be used to determine the fair value of the assets. The firm must use the same model for all assets of a similar type. U.S. GAAP reporting firms must use the cost model for long-lived assets.

LOS 26.i: explain the impairment of property, plant, and equipment and intangible assets
Question 26.10: Granite, Inc., owns a machine with a carrying value of $3.0 million and a salvage value of $2.0 million. The present value of the machine's future cash flows is $1.7 million. The asset is permanently impaired. Granite should:
A) immediately write down the machine to its salvage value.
B) immediately write down the machine to its recoverable amount.
C) write down the machine to its recoverable amount as soon as it is depreciated down to salvage value.
Explanation
B is correct. Under IFRS, when an asset is permanently impaired, it must be written down to its recoverable amount (greater of value in use or fair value less selling costs) in the period in which the impairment is recognized.

LOS 26.n: compare the financial reporting of investment property with that of property, plant, and equipment.
Question 26.11: Stone Development Company owns four office buildings and a tract of raw land. Stone occupies one of the buildings, collects rental income from the other three buildings, and is holding the land for capital appreciation. Under IFRS, which of these assets should Stone classify as investment property on its balance sheet?
A) All of these assets.
B) Only the land held for capital appreciation.
C) The land and the buildings that generate rental income.
Explanation
C is correct. Investment property is defined under IFRS as property held for the purpose of earning rental income, capital appreciation, or both. Owner-occupied property is not classified as investment property.