Question

1. Pears PLC adheres to IFRS. It recently imported inventory for $100 million, paid import tax of $ 2milion, carrying in cost of $5 million and spent $5 million for storage prior to selling the goods. The amount it charged to inventory expense ($ millions) was closest to:

1. $100
2. $105
3. $107
4. $115

2. In an inflationary environment, a LIFO liquidation will most likely result in an increase in:

1. Inventory.
2. Accounts payable.
3. Operating profit margin.
4. None of them.

3. The CFO of APEX, S.A. is selecting the depreciation method to use for a new machine. The machine has an expected useful life of six years. Production is expected to be low initially but to increase over time. The method chosen for tax reporting must be the same as the method used for financial reporting. If the CFO wants to maximize tax payments in the first year of the machine’s life, which of the following depreciation methods is the CFO most likely to use?

1. Units-of-production method.
2. Straight-line method.
3. Double-declining balance method.
4. None of the above.

Answer 1

1. Answer C : $107

As per IAS 2 the inventory cost is calculated as under.

Particulars	Amount
a. Cost of purchase	$ 100
Add: b. Import Tax	$2
Add: c. Carrying cost	$5
Total Inventory cost	$107

As per IAS 2, Cost should include all costs of purchase (including taxes, transport, and handling) net of trade discounts received costs of conversion (including fixed and variable manufacturing overheads) and other costs incurred in bringing the inventories to their present location and condition. But it should not include the storage cost. So we ignored the storage cost while calculating the Inventory cost.

2. Answer C: Operating profit Margin

LIFO liquidation occurs when an organization using the last in, first out concept to track its inventory costs uses up its oldest inventory layer. Under the LIFO method, the cost of the last inventory acquired is assigned to the first inventory used.

In an inflationary environment, when goods are sold and a LIFO liquidation results, the current price at which the goods are sold is matched against the presumably lower cost of goods from an earlier period, which results in an increase in Operating Profit Margin.

3. Answer A: Unit of Production Method

Here the CFO want to maximize the tax payments in the first year, that is he want a higher net profit margin in the initial years. So he need to charge a lower depreciation for higher profit.

As per IAS 16,

The units-of-production depreciation method is charging depreciation based on the production units, it assigns an equal amount of expense to each unit produced or service rendered by the asset. As it is clear from the question that the production is expected to be low in initial years and hence the depreciation based on this method will result a lower amount and the profit will increase, which will result in a higher amount of tax.

The double-declining balance is a type of accelerated depreciation method that calculates a higher depreciation charge in the first year of an asset’s life and gradually decreases depreciation expense in subsequent years. And which will result a lower tax in the initial years

Straight-line depreciation is the simplest and most popular method; it charges an equal amount of depreciation to each accounting period. Unit of production method is more useful in this situation.