Question

1. What other countries, if any, allow LIFO as a cost flow assumption?

2. What is the cash conversion cycle? Provide the formula and a definition.

Answer 1

1.

Definition of Last in First Out

1. Last in, first out (LIFO) is a method used to account for how inventory has been sold that rwill be recorded as per the the most recently produced or purchased items as sold first.

Banning of LIFO method

1. This method is banned under the International Financial Reporting Standards (IFRS), the accounting rules followed in the European Union (EU), Japan, Russia, Canada, India, and many other countries The U.S. is the only country that allows last in, first out (LIFO) because it adheres to Generally Accepted Accounting Principles (GAAP)

2. There are two alternatives to last in, first out (LIFO) for inventory costing: first in, first out (FIFO) and the average cost method. In first in, first out (FIFO), the oldest inventory items are recorded as sold first.

3. The average cost method takes the weighted average of all units available for sale during the accounting period and then uses that average cost to determine the cost of goods sold (COGS) and ending inventory.

How Last in, First out (LIFO) used in business

1. Under LIFO, a business records its newest products and inventory as the first items sold.

2. The opposite method is FIFO, where the oldest inventory is recorded as the first sold. While the business may not be literally selling the newest or oldest inventory, it uses this assumption for cost accounting purposes.

3. If the cost of buying inventory were the same every year, it would make no difference whether a business used the LIFO or the FIFO methods. But costs do change because, for many products, the price rises every year.

What are the Companies That get advantage From LIFO Cost Accounting

1. Businesses that sell products that rise in price every year benefit from using LIFO. When prices are rising, a business that uses LIFO can better match their revenues to their latest costs

2. . A business can also save on taxes that would have been accrued under other forms of cost accounting, and they can undertake fewer inventory write-downs.4

3. Virtually any industry that faces rising costs can benefit from using LIFO cost accounting. For example, many supermarkets and pharmacies use LIFO cost accounting because almost every good they stock experiences inflation. Many convenience stores—especially those that carry fuel and tobacco—elect to use LIFO because the costs of these products have risen substantially over time.

Negative comments of LIFO

1. Opponents of LIFO say that it distorts inventory figures on the balance sheet in times of high inflation.

2. They also point out that LIFO gives its users an unfair tax break because it can lower net income, and subsequently, lower the taxes a firm faces.

Effect of LIFO Tax Bills During Inflation

1. The higher COGS under LIFO decreases net profits and thus creates a lower tax bill for One Cup. This is why LIFO is controversial; opponents argue that during times of inflation, LIFO grants an unfair tax holiday for companies.

2. In response, proponents claim that any tax savings experienced by the firm are reinvested and are of no real consequence to the economy. Furthermore, proponents argue that a firm's tax bill when operating under FIFO is unfair (as a result of inflation).

Fewer Inventory Write-Downs Under LIFO

1. A final reason that companies elect to use LIFO is that there are fewer inventory write-downs under LIFO during times of inflation. An inventory write-down occurs when the inventory is deemed to have decreased in price below its carrying value. Under GAAP, inventory carrying amounts are recorded on the balance sheet at either the historical cost or the market cost, whichever is lower.

2. The market cost is constrained between an upper and lower bound: the net realizable value (the selling price less reasonable costs of completion and disposals) and the net realizable value minus normal profit margins. In inflationary conditions, the carrying amount of the inventories on a balance sheet already reflects the oldest costs of carrying and are the most conservative inventory values. Therefore, under LIFO, write-downs of inventory are usually unnecessary and rarely undertaken.

3. Moreover, because write-downs can reduce profitability (by increasing the costs of goods sold) and assets (by decreasing inventory), solvency, profitability, and liquidity ratios can all be negatively impacted. GAAP prohibits reversals of write-downs. As a result, firms that are subject to GAAP must ensure that all write-downs are absolutely necessary because they can have permanent consequences.

LIFO Reduces Taxes and Helps Match Revenue With Cost

During times of rising prices, companies may find it beneficial to use LIFO cost accounting over FIFO. Under LIFO, firms can save on taxes as well as better match their revenue to their latest costs when prices are rising.

2.Cash conversion cycle

1. The CCC is also referred to as the net operating cycle.

2. This cycle tells a business owner the average number of days it takes to purchase inventory, and then convert it to cash.

3. That is, it measures the time it takes a business to purchase supplies, turn them into a product or service, sell them, and collect accounts receivable (if needed).

4. The CCC time is dependent upon how a company finances its purchases, how it allows customers to pay (credit and the collection period), and how long it takes to collect.

5. A lower CCC is an indicator of a faster inventory-to-sales process. A higher CCC indicates a slower process. A low CCC is generally accepted as more desirable, although this depends on your business, industry, and capabilities.

Formula and calculation of Cash conversion cycle

You'll need to reference your financial statements such as the balance sheet and income statement to give you information for the calculations. The cash conversion cycle formula has three parts:

1. Days Inventory Outstanding,

2. Days Sales Outstanding, and

3. Days Payable Outstanding.

Days Inventory Outstanding

The first part of the equation is Days Inventory Outstanding (DIO). This is the average time to convert inventory into finished goods and sell them.

DIO = (Average Inventory ÷ Cost of Goods Sold) x 365

Your average inventory (in value) for the period is your beginning inventory value + ending inventory value ÷ 2.

(Beginning Inventory + Ending Inventory) ÷ 2

The cost of goods sold is:

Beginning Inventory + Purchases - Ending Inventory.

Days Sales Outstanding

Days Sales Outstanding (DSO) is the average amount of time in days that your accounts receivable (your business is owed money) are waiting to be collected.

DSO = (Accounts Receivable ÷ Net Credit Sales) x 365

Your accounts receivable for this element are the average of your beginning and ending receivables.

(Beginning Receivables + Ending Receivables) ÷ 2

Days Payable Outstanding

The Days Payable Outstanding (DPO) is the average length of time it takes a company to purchase from its suppliers on accounts payable—your business owes money—and pay for them.

DPO = Ending Accounts Payable ÷ (Cost of Goods Sold ÷ 365)

Accounts payable in this element is:

(Beginning Payable + Ending Payable) ÷ 2.

Once you have calculated all three of the required elements of the formula, you can calculate the CCC.

Cash Conversion Cycle (CCC) = DIO + DSO - DPO

Conclusion

The CCC is good information, but really only useful if you are calculating it every year and comparing it—along with the three elements of the formula—to your business' past performance.

You may be able to compare your CCC to your competitors if their financial information is available. If it is not, you can use this metric to develop strategies to improve the time it takes to sell your inventory, collect on receivables, and pay your bills.