8 Valuation of Inventories: A Cost-Basis Approach Financial Statement Analysis Cases 8
Financial Statement Analysis Cases
Case 1: T J International
T J International was founded in 1969 as Trus Joist International. The firm, a manufacturer of specialty building products, has its headquarters in Boise, Idaho. The company, through its partnership in the Trus Joist MacMillan joint venture, develops and manufactures engineered lumber. This product is a high-quality substitute for structural lumber and uses lower-grade wood and materials formerly considered waste. The company also is majority owner of the Outlook Window Partnership, which is a consortium of three wood and vinyl window manufacturers.
Following is T J International’s adapted income statement and information concerning inventories from its annual report…
Instructions
(a) How much would income before taxes have been if FIFO costing had been used to value all inventories?
(b) If the income tax rate is 46.6%, what would income tax have been if FIFO costing had been used to value all inventories?
In your opinion, is this difference in net income between the two methods material? Explain.
(c) Does the use of a different costing system for different types of inventory mean that there is a different physical flow of goods among the different types of inventory? Explain.
Case 2: Noven Pharmaceuticals, Inc.
Noven Pharmaceuticals, Inc., headquartered in Miami, Florida, describes itself in a recent annual report as follows.
Noven also reported in its annual report that its activities to date have consisted of product development efforts, some of which have been independent and some of which have been completed in conjunction with Rhone-Poulenc Rorer (RPR) and
Ciba-Geigy. The revenues so far have consisted of money received from licensing fees, “milestone” payments (payments made under licensing agreements when certain stages of the development of a certain product have been completed), and interest on its investments. The company expects that it will have significant revenue in the upcoming fiscal year from the launch of its first product, a transdermal estrogen delivery system.
The current assets portion of Noven’s balance sheet follows.
Inventories. Inventories are valued at the lower of cost or market and include material, labor, and production overhead costs. Inventories consisted of the following:
…
The last-in, first-out (LIFO) method is used for determining the cost of lumber, veneer, Microllam lumber,
TJI joists, and open web joists. Approximately 35 percent of total inventories at the end of the current year were valued using the LIFO method. The first-in, first-out (FIFO) method is used to determine the cost of all other inventories…
Inventory of supplies is recorded at the lower-of-cost (first-in, first-out)-or-net realizable value and consists mainly of supplies for research and development.
Instructions
(a) What would you expect the physical flow of goods for a pharmaceutical manufacturer to be most like: FIFO, LIFO, or random (flow of goods does not follow a set pattern)? Explain.
(b) What are some of the factors that Noven should consider as it selects an inventory measurement method?
(c) Suppose that Noven had $49,000 in an inventory of transdermal estrogen delivery patches. These patches are from an initial production run and will be sold during the coming year. Why do you think that this amount is not shown in a separate inventory account? In which of the accounts shown is the inventory likely to be? At what point will the inventory be transferred to a separate inventory account?
Noven Pharmaceuticals, Inc.
Noven is a place of ideas—a company where scientific excellence and state-of-the-art manufacturing combine to create new answers to human needs. Our transdermal delivery systems speed drugs painlessly and effortlessly into the bloodstream by means of a simple skin patch. This technology has proven applications in estrogen replacement, but at Noven we are developing a variety of systems incorporating bestselling drugs that fight everything from asthma, anxiety and dental pain to cancer, heart disease and neurological illness. Our research portfolio also includes new technologies, such as iontophoresis, in which drugs are delivered through the skin by means of electrical currents, as well as products that could satisfy broad consumer needs, such as our anti-microbial mouthrinse.
Instructions
(a) Compute Kroger’s inventory turnovers for fiscal years ending January 31, 2015, and February 1, 2014, using:
(1) Cost of sales and LIFO inventory.
(2) Cost of sales and FIFO inventory.
(b) Some firms calculate inventory turnover using sales rather than cost of goods sold in the numerator. Calculate Kroger’s fiscal years ending January 31, 2015, and February 1, 2014, turnover, using:
(1) Sales and LIFO inventory.
(2) Sales and FIFO inventory.
(c) State which method you would choose to evaluate Kroger’s performance. Justify your choice.
Accounting, Analysis, and Principles
Englehart Company sells two types of pumps. One is large and is for commercial use. The other is smaller and is used in residential swimming pools. The following inventory data is available for the month of March…
Accounting
(a) Assuming Englehart uses a periodic inventory system, determine the cost of inventory on hand at March 31 and the cost of goods sold for March under first-in, first-out (FIFO).
(b) Assume Englehart uses dollar-value LIFO and one pool, consisting of the combination of residential and commercial pumps. Determine the cost of inventory on hand at March 31 and the cost of goods sold for March. Assume Englehart’s initial adoption of LIFO is on March 1. Use the double-extension method to determine the appropriate price indices.
(Hint: The price index for February 28/March 1 should be 1.00.) (Round the index to three decimal places.)
Analysis
(a) Assume you need to compute a current ratio for Englehart. Which inventory method (FIFO or dollar-value LIFO) do you think would give you a more meaningful current ratio?
(b) Some of Englehart’s competitors use LIFO inventory costing and some use FIFO. How can an analyst compare the results of companies in an industry, when some use LIFO and others use FIFO?
Codification Exercises
If your school has a subscription to the FASB Codification, go to http://aaahq.org/asclogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses.
CE8-1 Access the glossary (“Master Glossary”) to answer the following.
(a) What is the definition provided for inventory?
(b) What is a customer?
(c) Under what conditions is a distributor considered a customer?
(d) What is a product financing arrangement?
CE8-2 Due to rising fuel costs, your client, Overstock.com, is considering adding a charge for shipping and handling costs on products sold through its website. What is the authoritative guidance for reporting these costs?
CE8-3 What guidance does the Codification provide concerning reporting inventories above cost?
CE8-4 What is the nature of the SEC guidance concerning the reporting of LIFO liquidations?
Codification Research Case
In conducting year-end inventory counts, your audit team is debating the impact of the client’s right of return policy both on inventory valuation and revenue recognition. The assistant controller argues that there is no need to worry about the return policies since they have not changed in a while. The audit senior wants a more authoritative answer and has asked you to conduct some research of the authoritative literature before she presses the point with the client.
Instructions
If your school has a subscription to the FASB Codification, go to http://aaahq.org/asclogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses.
(a) What is the authoritative guidance for revenue recognition when right of return exists?
(b) When is this guidance important for a company?
(c) Sales with high rates of return can ultimately cause inventory to be misstated. Why are returns allowed? Should different industries be able to make different types of return policies?
(d) In what situations would a reasonable estimate of returns be difficult to make?
