Reference no: EM131151184

Inventory Costing and Intangible Assets- ACCOUNTING ONLY

Inventory Methods

The main inventory control systems used in the United States are the First-In, First-Out (FIFO) and the Last-In, Last-Out (LIFO) methods. The methods are simply differentiated by the designation of which inventory is sold - the first or the last purchased. There are similarities between the two including using actual purchase cost rather than average cost, and obviously, there are differences.

In FIFO, when purchase costs are rising, the FIFO method assigns lower costs to the older goods sold and higher costs to the remaining inventory. This usually causes a business to report higher profits. This is great for reporting to the stockholder but there is a caveat - the company reporting a higher income pays more taxes.

In LIFO, you find the most controversial of inventory accounting methods. In fact, LIFO is only used in the good old United States. But, regardless of how it's viewed in other countries, there are strong arguments for the use of LIFO beyond the obvious lower tax burden. It also is a more conservative estimate of inventory.

U.S. public businesses can't use LIFO for tax purposes and FIFO for financial reporting. They have to be consistent. By peeking into a 10-Q or 10-K, you can quickly discover which firms use LIFO and which use FIFO. Just to name a few examples of who uses each type of method - Dell Computer uses FIFO. General Electric uses LIFO for its U.S. inventory and FIFO for international. Teen retailerHot Topic uses FIFO. Wal-Mart uses LIFO.

Just in Time (JIT) Manufacturing

JIT is the system of reducing inventory to a low level to reduce inventory costs without compromising production. Developed in Japan in the 1970's, it cut waste by supplying parts only as and when the process required them.

The utility that I worked for in Texas was considering building a new nuclear power plant. One of the presentations given by the prospective builders was the concept of JIT. There were a lot of positives with the concept but then there were also some concerns. If you produce only what you need when you need it, then there is no room for error. For JIT to work, many fundamental elements must be in place-steady production, flexible resources, extremely high quality, no machine breakdowns, reliable suppliers, quick machine set-ups, and lots of discipline to maintain the other elements. Just-in-time is both a philosophy and an integrated system for production management that evolved slowly through a trial-and-error process over a span of more than 15 years. There was no master plan or blueprint for JIT. We ultimately didn't build the power plant but I'm sure that the risks would have precluded a 100% commitment to JIT.

Activity Based Costing (ABC)

Activity-based costing provides a more accurate method of product/service costing, leading to more accurate pricing decisions. It increases understanding of overheads and cost drivers; and makes costly and non-value adding activities more visible, allowing managers to reduce or eliminate them. If you understand ABC and have the resources to fully implement it, then ABC appears to be effective in challenging of operating costs to find better ways of allocating and eliminating overheads.

Tangible and Intangible Assets

Tangible assets are physical assets such as land, vehicles, equipment, machinery, furniture, inventory, stock, bonds and cash. Intangible assets are nonphysical, such as patents, trademarks, franchises, goodwill and copyrights. AS we learned in previous chapter topics, tangible assets can and are depreciated. What I learned in researching for this topic is that there are intangible assets that can be amortized. Amortization usually refers to spreading an intangible asset's cost over that asset's useful life. Depreciation, on the other hand, refers to prorating a tangible asset's cost over that asset's life.

Once amortization begins, it is rarely changed unless there is evidence that the value of the intangible asset being amortized has become impaired. If so, there is an immediate write-down in the remaining value of the intangible asset in the amount of the impairment. At that point, you must evaluate whether the useful life of the asset has also changed, and modify the amortization calculation to incorporate not only the new useful life, but also the remaining (reduced) carrying amount of the asset.

These changes should be well-documented, since they will be examined by the company's auditors as part of the annual audit.

For example, ABC International acquires another company, and as a result recognizes a customer list asset in the amount of $1,000,000. ABC elects to amortize this intangible asset over the next five years at a rate of $200,000 per year. After one year, the carrying amount of the asset has been reduced to $800,000, but ABC now estimates that the asset has a market value of only $300,000 and a remaining useful life of just two years. Accordingly, ABC incurs a $500,000 impairment charge to write down the value of the asset to $300,000, and then re-sets the associated amortization to be $150,000 in each of the next two years. After that time, the customer list asset will have a carrying amount of zero in the accounting records of ABC.

Capital Expenditure and Revenue Expenditure

The final topic is the difference between capital expenditure and revenue expenditure. Capital expenditures are for fixed assets, which are expected to be productive assets for a long period of time. Revenue expenditures are for costs that are related to specific revenue transactions or operating periods, such as the cost of goods sold or repairs and maintenance expense. Thus, the differences between these two types of expenditures are as follows:

Timing. Capital expenditures are charged to expense gradually via depreciation, and over a long period of time. Revenue expenditures are charged to expense in the current period, or shortly thereafter.

Consumption. A capital expenditure is assumed to be consumed over the useful life of the related fixed asset. A revenue expenditure is assumed to be consumed within a very short period of time.

Size. A more questionable difference is that capital expenditures tend to involve larger monetary amounts than revenue expenditures. This is because an expenditure is only classified as a capital expenditure if it exceeds a certain threshold value; if not, it is automatically designated as a revenue expenditure. However, certain quite large expenditures can still be classified as revenue expenditures, as long they are directly associated with sale transactions or are period costs.

References:

FIFO and LIFO - https://en.wikipedia.org/wiki/FIFO_and_LIFO_accounting

FIFO or LIFO - https://www.businessnewsdaily.com/5514-fifo-lifo-differences.html

Lower of Cost or Market - https://en.wikipedia.org/wiki/Lower_of_cost_or_market

Kohls Adopts FIFO - https://www.wikinvest.com/stock/Kohl's_(KSS)/Merchandise_Inventories

Walmart Adopts FIFO - https://www.wikinvest.com/stock/Wal-Mart_(WMT)/Inventories

What the Fool says about FIFO/LIFO - https://www.fool.com/news/2003/03/20/inventory-ins-and-outs.aspx

Who Uses LIFO - https://www.investopedia.com/articles/investing/052815/when-why-should-company-use-lifo.asp

Activity Based Costing -https://www.cgma.org/Resources/Tools/essential-tools/Pages/activity-based-costing.aspx?TestCookiesEnabled=redirect

Just in Time - https://www.economist.com/node/13976392

Tangible and Intangible Assets - https://www.investopedia.com/ask/answers/012815/what-difference-between-tangible-and-intangible-assets.asp

Intangible Asset Amortization - https://www.accountingtools.com/intangible-assets-accounting

Depreciation - https://www.accountingtools.com/overview-of-depreciation

Capital and Revenue Expenditures - https://www.accountingtools.com/questions-and-answers/the-difference-between-capital-expenditures-and-revenue-expe.htm.