It took me quite a while to work on the Reading 35 problems. I need some help on #4 page 340 - 341. I think the key of this problem to get the right COGS and then the rest should be sailed through. I try to simplify of what I’m stuck on… Zenab uses LIFO for 70% of its inventory and FIFO for the remainder. I 20x1 = $24,900 and I 20x2 = $25,200 (I: inventory). If all inventories were carried at FIFO, I 20x1 would be $3,600 higher and I 20x2 would be $5,100 higher. Zenab 20x2 Income Statements show its COGS as $61,300. What would be its COGS under 100% FIFO and under 100% LIFO? Faybech uses FIFO for all inventories. I 20x1 = $22,300 and I 20x2 = $30,300 (I: inventory). Faybech 20x2 Income Statements show its COGS as $52,000, sales as $77,000 and general expense $21,500. What’s its COGS under LIFO? Hope I did not miss any info. to get the results. Thx for your help.
Thx much, map1. This would be helpful since the answer sheet only gave me results but no explanations.
After reading through cadlag’s lengthy explanation regarding this problem, I think it’s not as arduous as it initially appeared. What an awesome job! However, the inflation index calculation seems still debateful. From cadlag’s notes, I saw three different results. See excerpts below. I’m wondering in real test, which method will you apply? Shall we comply with CFA textbook? Can anyone clarify this? I personally agrees with cadlag’s thinking. ********************************************************************** So what part of Zenab’s ending 2001 inventory is LIFO? Seventy percent, of course! So this is a very neat conceptual breakthrough. However, there appears to be some judgment involved in determining what the phrase “BIF restricted to the LIFO portion of inventory” actually means in terms of our calculation. This is where I differ from the text¡¯s conversion. I believe that the inflation index should be based on strictly that portion of the ending inventory to which the LIFO reserves applies. Presumably, we apply the LIFO reserve to only the LIFO portion of the inventory. As such, we would be inclined to write: r=$1,500/(70% “of” $24,900)=0.0860 Now think about what makes up the $24,900: $17,430 (i.e., 70% LIFO) and $7,470 (i.e., 30% FIFO). When you are trying to calculate the inflation index, you don’t need to take into the account the $7,470 portion of the 2002 beginning balance because FIFO accounting already leaves inventory balances that are reflective of market prices and inflation. What you do need to be concerned about is the $17,430 LIFO portion – remember LIFO inventory balances generally are not reflective of market prices and inflation. Upon converting the $17,430 to FIFO, you should be able to get a sense of what inflation is really like for Zaneb’s inventory holdings. To do the conversion, I personally think we ought to do this: 70% of $24,900 plus $$3,600 = $17,430 + $3,600 = $21,030. The inflation index would then be $1,500/$21,030 = 0.0713. The text’s method is slightly different. It takes 70% of ($24,900 + $3,600) = $19,950. So the text’s inflation index (which is not shown at all) is $1,500 / $19,950 = 0.0751. **********************************************************************
Going to try and get this done during lunch, will check back. I noticed a lot in the errata for these practice problems as well, so beware.
Man, this was a bear of a problem, but well worth the time for the insight and thought process that it teaches. It is too bad the book did not do a better job of supplying an explanation, they seem to offer too much text in other places on not enough here. There were a few times where I was completely stuck and had to comb through my notes for an idea on where to turn to in order to derive the next piece, but I think I did reasonably well. Hyang - in terms of the inflation index calculation, I had a hard time deciding which one I agreed with as well. To me, the book’s method seems the most wrong, in that it takes only 70% of what is a fully FIFO inventory number. {70% of ($24,900 + $3,600) = $19,950}. But as I am typing this this a thought occured… perhaps this “wrongness” is offset because, by definition the COGS also contains a 70/30 split, and doing it cadlag’s way would slightly understate LIFO COGS? Just a thought, my head is spinning from this! In the end though, CFA test, so I would go with CFA rules. (This particular calculation is not mentioned in the errata.)
Yeah, I checked errata too… it did not appear there maybe because nobody confronted this question. So Paul, you are saying 70/30 LIFO/FIFO inventory split implies 70/30 LIFO/FIFO COGS split? That’s getting interesting… sounds reasonable though. Well, in this case, in order to calculate r, we only need Zenab’s change in LIFO Reserve (which is $1500) and its 20x2 beginning inventory under FIFO. So I think we really should focus on converting the LIFO portion of its 20x1 Ending Inventory $24,900 (which is the $17,430) into FIFO. After all, the r is a reference inflation index to calculate Faybech COGS under LIFO. So Faybech COGS(LIFO) = COGS(FIFO) + BI x r We’ve got Faybech’s COGS(FIFO)=$52,000 and BI=$22,300. r is calculated based on Zenab’s converted inventory data, why do you think it would understate LIFO COGS? Where’s the “wrongness” offset?
Hyang, >>“why do you think it would understate LIFO COGS? Where’s the “wrongness” offset?” I’m not sure of anything, it was just a thought that occurred to me a moment before I posted. I think you *might* prove it with this formula: BI + Purchases = EI + COGS Problem is that we have neither EI or BI for LIFO, and the book indicates that these are not possible to compute in the answer section. However, given that only purchases do not change based on the accounting methods, I would say that yes, a 70/30 split in inventory means a 70/30 split of COGS, else the equation would fall out of balance. Remember, the LIFO/FIFO adjustments merely shift around the allocation of costs, but they must go somewhere and they cannot change, costs are costs, matter cannot be created or destroyed, etc. I don’t mean to cop out, I’m having a hard enough time trying to muster up the energy to study after this wild day in the markets. Moreover, I’m afraid I just don’t have the knowledge to carry this discussion any further. We need an accounting expert. BusProf, where are you??
Chi Paul Wrote: ------------------------------------------------------- > I don’t mean to cop out, I’m having a hard enough > time trying to muster up the energy to study after > this wild day in the markets. I guess everyone was somewhat distracted by these massive market shifts. Indeed it’s hard to get into the books while the market was wild and crazy… Have you heard the Russian stock markets have been ordered closed for a second day and maybe more days? And British halted short selling in financial? (why not halt default credit swap???) Had US done the same, maybe LEH and MER won’t die that fast. What a shame! sigh… All US banks in the next five years will be divided by 2?