Analysis of Inventories

How the choice of cost formula (FIFO, weighted average, specific identification, LIFO) splits the cost of goods between the income statement and the balance sheet, how rising and falling prices change profits and ratios, how to convert LIFO figures to FIFO, how inventory is measured at the lower of cost and net realisable value under IFRS and US GAAP, and what inventory disclosures and ratios tell an analyst.

1. 1. Inventory cost formulas and inventory systemsEvery cost formula splits the same cost of goods available for sale between cost of sales and ending inventory; the formulas only disagree about which units are assumed to be sold.Video · 6 minFree13 min
2. 2. Rising and falling costs: effects on statements and ratiosWhen unit costs rise, FIFO reports lower cost of sales, higher profit and higher inventory than LIFO or weighted average; when costs fall, every one of those effects reverses.Video · 7 min14 min
3. 3. The LIFO reserve, LIFO-to-FIFO conversion and LIFO liquidationThe LIFO reserve is the gap between FIFO and LIFO inventory; adding it back, and its change to cost of sales, lets an analyst put a US GAAP LIFO company on the same footing as a FIFO or IFRS peer.Video · 6 min13 min
4. 4. Measuring inventory: lower of cost and net realisable valueInventory may not stay on the balance sheet above what it can be sold for, so it is written down when its value falls; IFRS reverses the write-down if value recovers, US GAAP never does.Video · 7 min13 min
5. 5. Inventory write-downs: effects on ratios and analysisA write-down lowers profit and assets, so it hurts profitability, liquidity and solvency ratios but flatters activity ratios; an analyst can undo it using the valuation allowance disclosed in the notes.12 min
6. 6. Inventory disclosures, ratios and analyst checksThe inventory note tells you the cost formula, the mix of raw materials, work in progress and finished goods, and the write-downs; combined with turnover, days on hand and gross margin, it reveals how well inventory is managed and where sales may be heading.13 min
7. 7. Integrated cases: reading the inventory note and restating to one basisA restatement question hides its inputs in a note: find the LIFO reserve, the valuation allowance and the write-down charge actually booked in cost of sales, then adjust inventory, cost of sales, income and equity, in that order.16 min
8. 8. Integrated cases: a two-year ratio panel and 'what if the cost formula changed'A full ratio panel is computed in a fixed order, then read as one story: activity, profitability, liquidity and solvency each explain part of what changed, and the cost formula or write-downs can move all of them.15 min