CFA CFA Level 2 Allowance for inventory obsolescence and cost of good sold

Allowance for inventory obsolescence and cost of good sold

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      Question: Assuming that any changes to the allowance for inventory obsolescence are reflected in COGS, what would HBL’s COGS be for 2012 if it had not recorded any inventory write-downs during the year?

      What I do not understand: In the given example, the solution was to subtract the change in inventory allowance in 2012 from the COGS if there is no inventory write down. What is the relation between inventory and COGS in this context? I couldn’t figured it out based on the standard accounting formula: beginning inventory + purchases = COGS + ending inventory.

      or can I assume the following – based on the standard accounting formula:

      Ending inventory – beginning inventory = change in inventory

      => change in inventory + purchases = COGS 

      Assume purchases remain unchanged, changes in the “change in inventory” leads to equivalent change to COGS?  

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      As always, in full disclosure, I am a level II candidate. IMHO, do not overthink this. The change in cumulative inventory write downs in 2012 was $3,315- $2,080= $1,235. The question explicitly states they charged the write downs through net income aggregated along with COGS. The reason for the write down could be for many reasons but probably because the firm was understating COGS in prior periods and/or over stating the value of its inventory. The write down is an added expense they charged to COGS (essentially taking all that built up understated COGS from prior periods and charging it all at once in the current period). This will over state COGS in the current period. Analysts might remove this additional write down effect to normalize COGS by subtracting that write down from COGS. In this case 2012 COGS $149,350- $1,235= $148,115. The COGS in 2012 of $149,350 included a write down charge (impairment) on its inventory of $1,235 which overstates COGS in the current period.

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      Just think of what you know about testing for inventory impairments and where those impairments flow through if there is one. Impairments go through the income statement. Sometimes it will have its own line on the income statement (inventory impairment charge). However sometimes firms may just aggregate it with another expense such as COGS.

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      Sorry, my assumption doesn’t make any sense. I need help! haha! 

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