Intermediate Accounting I Inventory Case Spring 2022 Learning Objectives · Understand the risks and benefits of holding inventory. · Explain how cost flow assumptions affect inventory balances and...

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Intermediate Accounting I
Inventory Case
Spring 2022
Learning Objectives
· Understand the risks and benefits of holding inventory.
· Explain how cost flow assumptions affect inventory balances and cost of goods sold.
· Analyze the activity in inventory and related accounts.
· Consider the financial statement effects of using different cost flow assumptions and of International Financial Reporting Standards (IFRS) for inventory.
· Restate a company's inventory balances and cost of sales to reflect IFRS-like reporting.
· Calculate inventory ratios under different cost flow assumptions.
Refer to the fiscal 2012 financial statements and notes of Deere & Company (10/31/2012) and CNH Global N.V. (12/31/2012). Note that Deere has an October 31 year end and CNH a December 31 year end.
Concepts
a. Explain the risks and benefits associated with holding inventory.
. Note 15 reveals that the balance sheet inventory amount consists of three types of inventory. What types of costs do you expect to be in the raw materials inventory? In the work-in-process inventory? In the finished goods inventory?
c. Why do companies use cost flow assumptions to determine inventory cost? What cost flow assumption(s) does Deere and Company use to determine inventory cost?
d. Assume that prices that Deere and CNH Global pay for inventory typically increase over time. CNH uses the first-in, first-out (FIFO) cost flow assumption to measure its inventories. In general terms, how do the balance sheet values for inventories of the two companies differ due to their cost flow assumptions? What numbers on the two companies' income statements would differ? What if prices typically decrease over time?
Process
e. Set up one T-account for Deere's total inventories (that is, combine the three inventory accounts for this analysis). Enter the 2011 (ie, the opening 2012 balance) and 2012 ending balances in the T-account. Use information from the financial statements to recreate the activity that took place in the account during fiscal 2012 and answer the following questions. Deere credits the total inventories account for the entire cost of sales. Note that the income statement line item Cost of Sales includes the labor and overhead needed to manufacture the inventory sold. Assume that the raw material costs represent half of the total cost of manufacturing the inventory.
a. How much raw material inventory did Deere purchase in fiscal 2012? Assume that raw material inventory was acquired in a single purchase. Provide the journal entry Deere made to record that purchase.
. Now set up a T-account for accounts payable and accrued expenses. Enter the 2011 ending balance (i.e., the opening 2012 balance) and 2012 ending balance in the T-account. Assume that "Accounts payable and accrued expenses" includes only inventory-related transactions with suppliers and that all raw material is purchased on account. How much did Deere pay its suppliers for inventory in fiscal 2012? Assume that Deere made a single payment to all its suppliers in fiscal 2012. Provide the journal entry Deere made to record that payment.
Analysis
f. You want to compare Deere's operations for fiscal 2012 to those of an international competitor, CNH Global, headquartered in the Netherlands. In particular, you want to compare a number of inventory related metrics. However, the two companies do not use the same inventory costing methods: Deere uses LIFO for a large portion of its inventory whereas CNH Global uses FIFO to measure all of its inventory. CNH Global prepares its financial statements according to U.S. GAAP, but it does not use LIFO. In that sense, CNH Global's financial statements report inventory as they would if they followed IFRS, which does not permit the use of LIFO.
To compare the two companies, you first must restate Deere's relevant balance sheet and income statement numbers from LIFO to FIFO. To do this, we assume that Deere had always used the FIFO cost flow method. Use the table below to aggregate the data you need to convert inventory from LIFO to FIFO for Deere. Information and analysis for 2010 and 2011 has been provided as guidance. For these calculations, assume that the marginal tax rate for Deere is 35%. Some data are already provided.
    Deere & Company
    2012
    2011
    2010
    Net sales
    
    $29,466.1
    $23,573.2
    LIFO cost of goods sold (COGS)
    
    21,919.4
    17,398.8
    LIFO net income
    
    2,799.9
    1,865.0
    LIFO inventory from balance sheet
    
    4,370.6
    3,063.01
    LIFO reserve from financial statement notes
    
    1,486.0
    1,398.01
    Total assets from the balance sheet
    
    48,207.4
    43,266.81
1Information from Deere's 2010 financial statements because 2010 balance sheet not included in the 2012 statements.
    Calculations to convert LIFO to FIFO:
    2012
    2011
    2010
    FIFO inventory = LIFO inventory + LIFO reserve
    
    5,856.6
    4,461.0
    FIFO assets = LIFO assets + LIFO reserve
    
    49,693.4
    44,664.8
    Change in LIFO reserve during the year (end – beg.)
    
    88.0
    
    FIFO COGS = LIFO COGS – Change in LIFO reserve
    
    21,831.4
    
    After-tax effect of LIFO method = (1-Marginal tax rate) x Change in LIFO reserve
    
    57.2
    
    FIFO net income = LIFO net income + After-tax effect of LIFO method
    
    2,857.1
    
Complete the table (in Excel) that follows using information from the financial statements and from the table you completed above. Comment on the results comparing CNH Global with Deere's 'As Reported' and 'As if FIFO' income statement and balance sheet information.
    Fiscal 2012
    Deere & Company
    CNH Global
    
    As reported
    As if FIFO
    As reported
    Common-size cost of goods sold1
    
    
    
    Net income
    
    
    
    Growth in net income
    
    
    
    Common-size net income
    
    
    
    Total assets
    
    
    
    Inventory
    
    
    
    Common-size inventory2
    
    
    
1To common-size items from the income statement, divide by total revenue attributable to equipment sales (that is, do not include revenues from each company's financing operations).
2To common size items from the balance sheet, divide by total assets.
g. The average inventory holding period is estimated using the following formula (the denominator is refe
ed to as the inventory turnover ratio):
Average Inventory Holding Period =
Use data from the financial statements to estimate the average inventory holding period for Deere and CNH Global for fiscal 2011 and 2012. Calculate the metric for both companies with their reported (ie, unadjusted) numbers. Additional information: CNH Global's inventory balance at the end of fiscal 2010 was $2,937. Evaluate how well Deere manages its inventory relative to its competitor, CNH Global.
Now recalculate the average holding period for Deere using their adjusted (ie, FIFO) numbers. Do you come to a different conclusion about their inventory turnover and management's relative performance?
h. Assume that Deere's inventory balances for accounting and for tax purposes are the same. Estimate the cumulative amount of income taxes through October 31, 2012, that Deere has defe
ed by choosing the LIFO method of inventory costing instead of the FIFO method. For these calculations, assume that the marginal tax rate for Deere is 35%.
i. Assume that you are the CEO of Deere and are considering the potential adoption of IFRS by U.S. firms. With respect to inventory accounting in particular, do you have any concerns about Deere conversion to IFRS? Prepare a short letter to the Chair of the SEC outlining your concerns.
Answered 4 days AfterApr 05, 2022

Solution

Nitish Lath answered on Apr 09 2022
16 Votes
a. There are various benefits and risks associated with holding inventory. The major benefits include avoiding of losing sales due to availability of inventory during entire period, higher quantity discounts due to bulk purchases, reduction in ordering costs, higher production efficiency due to longer production run, reduction in risk of production shortage. The major risks associated with holding inventory is risk of obsolescence, higher inventory ca
ying cost, risk of decline in price, shortfall in cash flows and inefficient working capital management.
. In case of raw material inventory, the costs mainly include the purchase costs of raw material, freight and shipping changes and taxes on which input credit is not admissible. The cost of Work in progress inventory includes raw material cost plus conversion cost to the extent of process completed and incu
ed. The cost of finished goods includes raw material cost, conversion cost such as direct labor and expenses, manufacturing overheads and other conversion costs.
c. The cost flows assumptions are necessary because the costs are changing with the period of time and the inflation also impact the cost of inventory. The monitoring of physical flow of inventory is very difficult and the cost of inventory keep on changing with every purchase lot and for valuation of inventory and keeping uniformity, cost flow assumption is used by the companies. In case of Deere & Co. the inventory owned by the entity and its U.S. equipment subsidiary are valued at cost on the LIFO basis whereas the remaining inventory are valued at lower of cost based on FIFO or market value.
d. In terms of cost flow assumption, the balance sheet values will differ for both the companies. CNH is using FIFO method of accounting whereas Dheere & Co is using LIFO method of accounting. In case of increasing prices, the prices will be higher in case of recent purchases and the value of inventory will be higher in case of CNH company and the value of inventory will be lower in case of Dheere & Co due to consideration of oldest items purchased at lower value. In income statement the COGS for Dheere & Co will be higher whereas in case CNH company the COGS will be lower and net profit will be higher. If the prices are decreasing over the time then the...
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