{"id":4445,"date":"2019-08-28T17:36:00","date_gmt":"2019-08-28T17:36:00","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=4445"},"modified":"2025-04-03T11:16:08","modified_gmt":"2025-04-03T11:16:08","slug":"company-inventory-disclosures-other-sources-information","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/financial-reporting-and-analysis\/company-inventory-disclosures-other-sources-information\/","title":{"rendered":"Examining a Company\u2019s Inventory Disclosures and Other Sources of Information"},"content":{"rendered":"<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/l-UYPyppmzs\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>Financial statement analyses that fail to consider the impact of differences in methodologies adopted, disclosures made, and presentation formats are likely to result in faulty conclusions.<\/p>\n<p>An analyst has to have a critical mind and give consideration to the information at their disposal which supports the financial statements that have been presented. Information on a company\u2019s inventory disclosures is no exception.<\/p>\n<h2><strong>Considerations Relating to Inventory Disclosures<\/strong><\/h2>\n<p>Analysts must recognize that a company\u2019s choice of inventory valuation method can have a significant impact on the presentation of its financial statements. Therefore, financial items such as cost of sales, gross profit, net income, inventories, current assets, and total assets will be impacted.<\/p>\n<p>The financial ratios which contain items such as the current ratio, return on assets, gross profit margin, and inventory turnover, will also be impacted. The current ratio is impacted because inventory is a component of current assets. On the other hand, the return on assets ratio is impacted because the cost of sales is a key component in the derivation of net income and inventory is a component of total assets.<\/p>\n<p>The financial statement items and financial ratios may also be impacted by the adjustment of inventory carrying amount to net realizable value or current replacement cost.<\/p>\n<p>Analysts must therefore carefully consider inventory valuation method differences when evaluating a company\u2019s financial performance over time. Especially, they must do so when comparing a company&#8217;s performance with the performance of its peers or industry as a whole.<\/p>\n<p>To better use the inventory disclosure information, an analyst needs to get a better understanding of:<\/p>\n<ul>\n<li>the right size for the company\u2019s inventory;<\/li>\n<li>the percentage change of the categories composing the inventory;<\/li>\n<li>the growth rate of inventory compared to the growth rate of sales; and<\/li>\n<li>other sources of information.<\/li>\n<\/ul>\n<h2><strong>Inventory Size<\/strong><\/h2>\n<p>If a company\u2019s inventory is too small, it might miss selling opportunities. If a company invests too much in its inventory, it would negatively affect most of the financial ratios. To figure out whether a company\u2019s inventory has the right size or not, an analyst needs to compare the company\u2019s inventory turnover ratio with the trend of the company\u2019s sales.<\/p>\n<h2><strong>Inventory Composing Category<\/strong><\/h2>\n<p>The percentage change of categories composing the inventory could be a signal of a company\u2019s management&#8217;s expectations about future demand for the company\u2019s products. The percentage increase of \u201cfinished goods\u201d and \u201cwork-in-progress\u201d indicates an expectation of high demand for a company\u2019s products. On the other hand, if \u201cfinished goods\u201d increase \u2013 in terms of percentage \u2013 it might indicate a slower growth of sales in the future.<\/p>\n<h2><strong>Inventory Growth Rate Relative to Sales<\/strong><\/h2>\n<p>An analyst needs to compare the growth rate of a company\u2019s \u201cfinished goods\u201d and the growth rate of its sales. If they move in tandem, it could be an indicator of steady sales growth trends. If either outpaces the other, it might be an indicator that the sales growth rate would either reverse or slow down.<\/p>\n<h2><strong>Other Sources of Information<\/strong><\/h2>\n<p>Analysts should also consider additional information about a company\u2019s inventory and its future sales which may be found in other sources such as the Management, Discussion, and Analysis (MD&amp;A). Alternatively, an analyst could seek more information on a company in similar sections of the company\u2019s financial reports, industry-related news, publications, and industry economic data.<\/p>\n<blockquote>\n<h3><strong>Question 1<\/strong><\/h3>\n<p>Which of the following financial statement items is <em>not<\/em> directly affected by the choice of inventory valuation method?<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">Revenue.<\/li>\n<li data-tadv-p=\"keep\">Net income.<\/li>\n<li data-tadv-p=\"keep\">Cost of sales.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>A<\/strong>.<\/p>\n<p>Revenue is not affected by the choice of inventory valuation method. Net income and cost of sales, on the other hand, are.<\/p>\n<h3><strong>Question 2<\/strong><\/h3>\n<p>After analyzing the latest financial reports of Yeez Company, an analyst noticed that the ratio of \u201cfinished goods\u201d to overall inventory is decreasing and the ratio of \u201cfinished goods\u201d to sales is also decreasing. The analyst would most likely conclude that:<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">The sales trend is rising.<\/li>\n<li data-tadv-p=\"keep\">The sales trend is declining.<\/li>\n<li data-tadv-p=\"keep\">The information is not sufficient to make any conclusion.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>B<\/strong>.<\/p>\n<p>The percentage decrease of \u201cfinished goods\u201d as an inventory component suggests that the company\u2019s management expects a slowdown in sales. The decrease of \u201cfinished goods\u201d to sales confirms the previous conclusion.<\/p>\n<\/blockquote>\n","protected":false},"excerpt":{"rendered":"<p>Financial statement analyses that fail to consider the impact of differences in methodologies adopted, disclosures made, and presentation formats are likely to result in faulty conclusions. An analyst has to have a critical mind and give consideration to the information&#8230;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[5],"tags":[],"class_list":["post-4445","post","type-post","status-publish","format-standard","hentry","category-financial-reporting-and-analysis","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Inventory Disclosures &amp; Analysis | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Learn how to analyze inventory disclosures and related info in financial statements. 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