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Impacts of LIFO and FIFO Inventory Methods on Selected Financial Ratios

FINANCIAL STATEMENT/RATIO FIFO LIFO Net Income and Profit Margins Usually higher in a rising price environment. Usually lower in a rising price environment. Pre-tax Cash Flow Same. Same. After-tax Cash Flow Usually lower in a rising price environment because a company is reporting higher net income due to lower COGS. Usually higher in a rising

Inventory at Net Realizable Value

International and U.S. accounting standards require companies to carry inventory on the balance sheet at the lower of cost or market (LCM). With LCM an unrealized loss caused by a change that materially disconnects the in the fair market value of current inventory from the most recently reported book value of inventory must be immediately

LIFO Liquidation

LIFO Liquidation and a Declining LIFO Reserve A declining LIFO reserve can indicate inventory liquidation or falling prices.  If LIFO reserve declines in a rising price environment, then the analyst might become suspicious that current profit margins are over-stated because older goods are being sold and not replaced.  Replacing these goods at current cost might

LIFO Reserve and Converting LIFO Net Income to FIFO Net Income

When a company uses the LIFO method, accounting standards may require a footnote disclosing what inventory values would be under the FIFO accounting method. A company’s LIFO reserve may increase yearly due to rising inventories and rising price levels, but sometimes the LIFO reserve declines.

LIFO – Tax and Cash Flow Note

A company’s pre-tax cash flows are not affected by the choice of LIFO versus FIFO. In the US, a tax law known as the “LIFO conformity rule” mandates that if a US company uses LIFO for tax reporting, it must also use LIFO for public financial reporting (i.e. U.S. GAAP reporting). When prices are rising,

Inflation/Deflation and Inventory Accounting Analysis

Inflation and inventory accounting analysis LIFO income statement in a rising price environment – LIFO method will lower reported margins.  Most recent goods are the most expensive and LIFO will calculate higher COGS and thus a lower gross profit. LIFO balance sheet in a rising pricing environment – LIFO method lowers the value of inventory

Inventory Accounting and Financial Statements

Inventory accounting directly impacts a company’s income statement and balance sheet.  There are also tax implications for the choice of inventory accounting method, which impacts after-tax cash flows. Income Statement Income statement represents a company’s financial performance over a period of time.  A company’s LIFO gross margin could be materially different that its FIFO gross

FIFO and LIFO Methods for Inventory Expensing

Inventory Inventory refers to the short-term assets on a company’s balance sheet; example – a retail clothier’s stock of shirts, pants, etc. FIFO First-in, first-out accounting method, where the costs of the oldest items in inventory are used to compute the cost of goods sold (COGS) expense on a company’s income statement. FIFO ending inventory

Financial Reporting: Important Definitions

Financial Reporting: The act of providing statutorily mandated financial information to the investing public; different countries have different requirements and standards. Financial Statements Refer to a company’s: income statement, balance sheet, statement of cash flows, and/or statement of changes in owner’s equity. Long-term Assets: Include long lived assets and long-term investments, both of which are

CFA Level 2: Financial Reporting Part 1 – Introduction

Adjusting reported financial statements of public companies for the purposes of comparing them or assessing their stand alone valuations is long time CFA exam material.  Entry level equity and credit analyst jobs require proficiency in financial statement analysis.  Today is world of on-demand financial data, with services such as Bloomberg.  However, if an analyst is