Question

Applying IFRS - LVMH is a Paris-based manufacturer of luxury goods that prepares its financial statements using IFRS. During the year, the management of the company undertook a review of the fair value of its inventory and found that the inventory had appreciated above its book value of 12 million euros. According to the company’s management, the inventory was undervalued by 2 million euros. Prepare the journal entry to revalue the company’s inventory. How would the revaluation immediately affect the company’s (a) current ratio, (b) inventory turnover, and (c) days’ sales in inventory?

Answer 1

Solution:

Part 1 --- Journal Entry to revalue inventory

Under IFRS the inventories are reported for the period at cost or net realizable value (NRV) whichever is lower.

The difference is charged to income statement as write down expenses and inventories are reduced with that amount.

Journal Entry to revalue the company’s inventory

Accounts	Debit	Credit
Inventory write down (Expense) or Cost of Goods Sold	Euro 2,000,000
Inventory		Euro 2,000,000

Part 2(a) – Affect on Current Ratio of the company

Inventories are a part of current assets. Since inventories are reduced to revalue at lower of cost or NRV. Current Assets are reduced by Euro 2 Millions.

Hence, the current ratio will be decreased.

Part 2(b) – Inventory Turnover

Inventory turnover ratio describes that how fast inventory is converted into sale. This ratio shows the company’s ability to convert its inventory into sales.

Mathematically, it is calculated as follows:

Inventory Turnover = Cost of Goods Sold / Average Inventory

Since inventory will be reduced and the reduction in inventory will be charged to Income Statement as expenses. So there will be no change in this ratio.

Part 2(c) --- There will be no change in Days sales in inventory since Inventory Turnover Ratio will remain same.

Days sales in inventory = 365 Days / Inventory Turnover

Inventory Turnover will remain same and no affect will be there related to the revaluation of inventory.

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