Financial ment Analysis a) LIFO method of accounting for inventory is re d into FIFO method as per the requirement of US GAAP. US GAAP requires the companies who use LIFO based accounting for inventories to show a disclosure for FIFO based accounting in the footnotes of financial statements (Investopedia, n.d. ). The following is the formula which is used for restatement of LIFO into FIFO: FIFO inventory = LIFO inventory + LIFO reserve Cost of goods sold under LIFO based inventory is restated into the following way: COGS (FIFO) = COGS (LIFO) – Change in LIFO reserve However, Six Sigma uses weighted average method of inventory which does not incorporate the restatement of LIFO into FIFO or vice versa. b) LIFO liquidation is a process by which the companies can manipulate their financial footings.
In case when the companies want to show lower amounts of profits and accordingly lower tax liabilities, they liquidate the older inventory. It means that the older inventory valued earlier at lower cost is liquidated into a relatively higher cost and thus increases the cost of production which makes the profits shrunk and reduces the tax liability. c) The LIFO liquidation makes the inventory valuation at a higher amount which thus reduces the inventory turnover (Jan, n.d. )..
The higher the inventory turnover, the lesser will be the cost of holding the old inventory, the more efficient will be the utilization of funds. Due to LIFO liquidation, inventory turnover decreases and thus increases the holding cost resulting in increased utilization of funds. 3) a) Due to a change in the average useful life of an asset, it is not needed to restate the entire financial statements because change in the average useful life of an asset is not a change in accounting policy rather it is just a change in management’s assumptions (Investopedia, n.d. ).
In case of a decrease in the average useful life of the assets, the existing and future depreciation expense of the company will increase which will result in a decrease of net income. On the other hand, if the average useful life of the assets is increased, it will reduce the depreciation expense in the current and future years and thus resulting in higher profitability. b) Profitability ratios are highly impacted due to a change in the average useful life of the assets of the company.
Most of the profitability ratios such as net profit margin, return on equity, return on assets etc. are increased if the average useful life of the assets is increased whereas they are reduced if the average useful life of the assets of the companies is shortened. 4) a) Expenses are mainly recognized based on two reputed methods of accounting i. e. cash based and accrual based. Based on cash, expenses are recognized in the financial statements when they are paid.
However, based on accrual system of accounting, expenses are recognized when they are incurred, not when they are paid. Almost every corporation is required to follow accrual basis of accounting. b) As far as restatement of financial statement is considered due to expense recognitions, there is no need for restatement as the financial statements of the companies are already prepared on accrual based of accounting which shows that all the expenses amounts presented in the financial statements are recognized when they are actually incurred. 5) a) Fair value accounting and historical cost accounting basis, have become a common debate among finance professionals.
When it comes to calculation, inventories and property, plant and equipment and assets and liabilities denominated in foreign currency are valued at historical costs. However, financial instruments (especially derivatives), revaluation model of property, plant and equipment and those economies which are hyper-inflationary are required to use fair value basis of accounting. On the other hand, investors always consider the fair values as the more meaningful source of their decision-making. For that reason, market share price of the company represents fair market value of the company, whereas for historical cost based valuation of the company, book values are divided by the no.
of shares outstanding to arrive at historical value or book value of the company. b) Since the diversion from historical cost basis to fair value basis (e. g. cost model into revaluation model in case of PPE), is a change in the accounting estimate. In case of such change in accounting estimate, it is not required to restate the entire financial statements rather only the current year’s amounts are restated with the estimates that are currently applied. c) Fair value accounting at times becomes quite tough because it becomes even difficult to obtain the fair values of the assets and liabilities as the likelihood of over and understatement stays with this method of accounting.
On the other hand, historical cost basis of accounting becomes useless for the stakeholders because past data does not reflect the existing financial performance and position of the company. In this way, both these models have their own pros and cons for their application and adoption. 6) Impairment of assets occurs when the management considers their assets to be impaired when carrying amount becomes higher than the recoverable amount Deloitte, (n. d.).
In that case, the companies impair their assets and such impaired amount is charged as an impairment loss in the financial statements. However, when there are chances that the asset previously impaired, has a recoverable amount exceeding the carrying amount, then the amount of reversal is charged in the profit and loss account. Profitability ratios become better as a result of reversal of impairment as the net income of the company increases. 7) Marketable securities are the short-term securities that companies own as part of their liquid assets.
Gains or losses arising on these marketable securities are stated in the statement of comprehensive income and ultimately equity side of the balance sheet is affected due to gains/losses in the marketable securities. 8) a) In order to hedge the unfavorable effects in the financial instruments, derivatives are used as a measure of hedging such movements. Financial assets and/or liabilities are created so that the unfavorable movements can be dealt with effectively, i.e.
minimizing the financial risk of the company. These financial assets and liabilities are created in the balance sheet of the company. b) Derivatives are the chief sources of hedge instruments and generally, they are of four types, i.e. forward, futures, swaps and options. The calculation of the amount hedged is computed as the amount which derivative will drive at the time of exercising the derivative less the cost of purchasing the derivative. 9) a) Foreign currency exposures arise when remittance in foreign currency is to arrive or the payment in foreign currency is due. Downside risk of foreign currency holds in case of remittance and upside risk remains in case of payments.
Generally, changes in foreign currency exposures are recognized in the profit and loss account (Weygandt, Kimmel, Kieso, 2010). b) Gains and losses due to foreign currency exposures are recognized in the income statements. Losses are expensed out whereas gains are recorded as the income. c) All four kinds of derivatives are used for mitigating the foreign currency risk exposure. Forward is a binding contract to buy or sell the foreign currency at the pre-agreed price at the specific date.
However, counterparty default risk is present. Futures are the standard contracts maturing at a certain date but no counterparty risk is involved. For swaps, other party in the foreign currency with the same problem needs to be sought out for the execution. For options, in case of unfavorable movement of foreign currency, options are exercised otherwise they are lapsed. However, the premium amount is to be paid whether or not options are exercised. References "IAS 36 — Impairment of Assets. " Deloitte. N.p. , Web. 15 Apr. 2014.. "CFA Level 1." Investopedia. N.p. , Web.
15 Apr. 2014.. "Inventory Turnover. " Investopedia. N.p. , Web. 15 Apr. 2014.. Jan, Irfanullah. "Inventory Turnover Ratio. " Accounting Explained. N.p. , Web. 15 Apr. 2014.. Weygandt, Paul D., Kimmel, Kieso, Donald E. Financial Accounting: IFRS Edition. Chicago: John Wiley & Sons, 2010. Print.