International Financial Reporting Standards_guide.pdf

190 Chapter 16 Inventories (IAS 2)
EXAMPLE 16.4
An entity has a current ratio greater than 1.0. If the entity’s ending inventory is understated
by $3,000 and beginning inventory is overstated by $5,000, the entity’s net income and the
current ratio would be
Net Income
Current Ratio
a. Understated by $2,000 Lower
b. Overstated by $2,000 Lower
c. Understated by $8,000 Lower
d. Overstated $8,000 Higher
EXPLANATION
Choice c. is correct. The answer was derived from the following calculations:
Δ COGS = Δ Beginning Inventory + Δ Purchases − Δ Ending Inventory
= $5,000 + P − (− $3,000)
Assuming Δ P = 0
Δ COGS = $5,000 + $3,000 = $8,000
If COGS is overstated by $8,000, then net income is understated by $8,000 (assuming taxes
are zero). If the ending inventory is understated, then the current ratio is also lower because
inventory is part of current assets.
EXAMPLE 16.5 (READ TOGETHER WITH IAS 39)
A portfolio manager purchases and sells the following securities over a four-day period. On
day 5, the manager sells five securities at $4 each. Although IFRS does not allow LIFO as a
cost formula, determine
i) the cost price of the securities, using the FIFO, LIFO, and weighted average cost (WAC)
formulae; and
ii) the profit that will be disclosed under each of the three alternatives.
EXPLANATION
Determining the “Buy” Cost Related to the Sell
Day Buy Par Sell Par FIFO LIFO WAC
1 10 at $1 5 at $1
2 15 at $2
3 20 at $3 5 at $3
4 5 at $4
Average 45 at $2.22 5 at $2.22
(a) Cost price
5 (20) 15 (20) 11 (20)
Selling price
(b) Profit (15) (5) (9)