The difference between both the methods of measuring inventory is the way in which the cost of goods sold is calculated. A company ideally does not keep a track of every single piece of incoming and outgoing goods hence it is required to calculate the inventory at the end of an accounting period. There are two methods of calculating the inventory that is FIFO and LIFO. Fifo means first in first out, so whatever goods come in first are sold in the same order. Hence the goods that were purchased last will remain in the inventory. In case of LIFO, the goods which come in at last are sold first. The first purchases will generally remain in the inventory. Whatever comes in as purchase or production is sold. Most recently acquired items are sold first. An example of a hypothetical firm is shown below. Its effects on accounting can be seen below.
In case of FIFO, the goods at the beginning of the period will be sold first and the inventory will consist of goods purchased on Oct 15. It is also assumed that the beginning inventory is 4000 units. Hence the initial sales will be from the beginning inventory followed by the purchases. The inventory for the same under FIFO is 4500 units. As for LIFO, the sales will be from the purchase of 17 Jan and not from the beginning inventory. The inventory for the period will be 4500 units including beginning inventory. Though the units in both the cases are same, its value will be different because of the different prices at which the goods have been purchased. In case of FIFO, the value of inventory will be $33000 and in case of LIFO, the same will be $25000. This is the basic difference between the two methods of inventory valuation.
The impact of FIFO on the current assets can be seen in case of rising prices and falling prices. So if the prices are rising and a firm is using FIFO method, the inventory will be high and the cost of goods sold will be low due to which the profits will be high. The current assets will also be high. The overall profit will show a reduction. In case a firm using FIFO is going through a fall in prices, the inventory will be low and so will the current assets be. The overall profits will be high because of the higher cost of goods sold. The gross profit has a direct impact of the inventory valuation method.
The impact of LIFO can be similarly seen, in case of rising prices the inventory value will be low and the current assets will also be low. The gross profit will be low as the cost of goods sold will be high. LIFO shows opposite and inverse effect from FIFO. In case of falling prices, LIFO will show a higher ending inventory with a high current asset and a high gross profit. This happens due to a lower value of cost of goods sold. Many a times accountants manipulate the inventory so as show a lower gross profit. To avoid the occurrence of such events, the Board has provided accounting guidelines which require the firms to provide a method of valuation and stick to the same unless advised by the Board. Inventory has a dual effect, on the profit as well as the current assets. It changes the balance sheet if a small change in inventory is noticed.
Two annual reports namely Virgin Media and Cheniere Energy Inc. are taken here. The analysis of the footnotes of the reports is provided further. As for Cheniere Energy Inc. the footnotes provide information about the equity and liability information. The equity consists of the stock issued and outstanding, the equity shares have been issued during 2013 and they show a slight increase as compared to the previous year. The treasury stock which is maintained as a reserve by the company has shown a deficit. The deficit has increased over the year. The equity section also shows an additional capital which was paid for including the total deficit during the period. The total amount of shareholders equity has been provided which includes the initial issued capital and the deficit along with the paid up capital. The value for the shareholders equity shares have been given. As for liabilities, the company has mentioned all the liabilities as long term, short term and current liabilities. Along with the shareholders equity, the total liability has been shown which includes all the liabilities of the company and the equity part of the same. The company has also shown noncontrolling interest which is the investment it has in other equity but does not hold any control over the same. Thus, other than current liabilities the long term and short term debt has been specifically shown.
In case of Virgin Media, the analysis of financial statements show that the equity of the company has shown common stock and additional paid up capital. The accumulated deficit is also seen in the balance sheet which is added to the equity and the total of equity holdings and liabilities is shown. Equity includes share based compensation, dividends, repurchase of common stock and effect of share based compensations. Thus the total amount of equity reflects all the transactions which took place in the shares of the company. The liabilities are again divided into account payables, long term debts, interest and related party payables. The specific headings show the amount to be paid. It also includes the current portion of the debt and lease obligations which are to be paid in the coming period. The liabilities include derivative instruments which are affected due to changes in the currency rates. The effect on assets due to the interest rate and cross currency rates is seen.
A note also provides details about the debt and lease obligations, the fair value and carrying value are shown which reflect the amount of convertible notes, credit facility and vendor financing. The company has 111 shares of common stock outstanding. The company received a cash contribution which was used to repay a facility agreement. The company also received non cash contribution in relation to deferred financing cost and in relation to transfer of shares to a trust in exchange for a note. The company mentions that it has not issued any common stock nor has it repurchased the same. Thus the total equity and liabilities show the total amount attributable to the shareholders and the liability of the company. It basically consists of various transactions carried out throughout the year. The notes provide details of the same.
References
Impact on inventory method on financial statement analysis. (n.d.). Retrieved from Boundless: https://www.boundless.com/accounting/textbooks/boundless-accounting-textbook/controlling-and-reporting-of-inventories-5/assessing-inventory-management-39/impact-of-inventory-method-on-financial-statement-analysis-226-4884/
Methods of Valuing Inventory. (n.d.). Retrieved from US Legal: http://inventories.uslegal.com/methods-of-valuing-inventory/
