Audit

audit

BBUS 411

In class exercise 3

Consider each of the following independent scenarios and address each set of questions separately.

(a) Nygren Inc., a manufacturer of transportation equipment, maintains stock areas for raw materials inventory in each plant. Nygren’s policy is that, at any time, each plant maintains raw materials inventory levels at around 10% of the total amount of each item that would be used in production in a typical year. Nygren management knows it has a choice within GAAP between FIFO, LIFO, average cost, and specific identification methods to measure its cost of goods sold and inventory cost for its financial statements.

(1) Which types of assertions are impacted by management’s choice of cost flow method for inventory? Explain fully.

Occurrence (timing): An important event in accounting for inventory is the transfer of cost from the inventory T-account to cost of goods sold as the result of a sale. The inventory balance is reduced and the related expense is increased. In case if inventory items are acquired at different costs, we need to know which cost is moved from asset to expense. At that point, a cost flow assumption must be selected by company. That choice can have a significant impact on both the income statement and the balance sheet. It is impossible to analyze the reported net income and inventory balance of a company without knowing the cost flow assumption that has been applied.

Valuation: Did they value correctly an inventory accounts and inventory?

Specific-identification basis, FIFO, LIFO, average cost —what information do these terms provide? Why company is using different methods? In the financial reporting of inventory, what is the significance of disclosing that a company applies FIFO, LIFO, or average cost?

Assertions impacted: occurrence, completeness, and valuation.

(2) For each inventory cost flow method shown above, discuss how (i) the method itself and (ii) management’s application of...