Inventory Additional Issues

8/10/2019 Inventory Additional Issues

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2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

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9-2

Lower of Cost or Market (LCM)

GAAP requires that inventories be

carried at cost or current marketvalue, whichever is lower.

GAAP requires that inventories becarried at cost or current market

value, whichever is lower.

LCM is a dearture !rom historical costand is a conservative accountin"

method.

LCM is a dearture !rom historical costand is a conservative accountin"

method.


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Slide

9-3

Determining Market Value

#et $eali%able&alue 'Ceilin"(

#et $eali%able &alueless #ormal Pro!it

')loor(

Market value is #*+Market value is #*+

necessarily thenecessarily the

amount !or whichamount !or which

inventory can beinventory can besold.sold.

Accountin" $esearchAccountin" $esearch

ulletin #o. -ulletin #o. -

de!ines /marketde!ines /marketvalue0 in terms o!value0 in terms o!

current relacementcurrent relacement

cost.cost.


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9-4




')loor(

#et $eali%able &alue '#$&( isthe estimated sellin" riceless cost o! comletion and

disosal.

#et $eali%able &alue '#$&( isthe estimated sellin" riceless cost o! comletion and

disosal.

$elacementCost

$elacementCost

+he de!inition o!+he de!inition o! marketmarketvaluevaluevariesvaries

internationally. In the 12,internationally. In the 12,

3enmark, )inland, and3enmark, )inland, and

#ew 4ealand, market#ew 4ealand, market

value is de!ined as #$&.value is de!ined as #$&.

+he de!inition o!+he de!inition o! marketmarketvaluevaluevariesvaries

internationally. In the 12,internationally. In the 12,

3enmark, )inland, and3enmark, )inland, and

#ew 4ealand, market#ew 4ealand, market

value is de!ined as #$&.value is de!ined as #$&.


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9-5



')loor(


I! relacement cost5 Ceilin", then

Ceilin"6 Market

&alue $elacementCost

$elacementCost

I! relacementcost 7 )loor, then

)loor6 Market&alue


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7/46 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Slide

9-7

LCM - Example


#et $eali%able&alue less #ormal

Pro!it ')loor(

$elacementCost 689?.@


hich one dowe use>



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9-8

Market value 6 89?.@Market value 6 89?.@

Cost 6 89.Cost 6 89.

=hould the inventory be=hould the inventory be

recorded at cost or market>recorded at cost or market>



=hould the inventory be=hould the inventory be

recorded at cost or market>recorded at cost or market>



=ince Cost 7 Market, the LCM=ince Cost 7 Market, the LCM

rule would dictate that inventoryrule would dictate that inventory

be recorded at Cost.be recorded at Cost.



=ince Cost 7 Market, the LCM=ince Cost 7 Market, the LCM

rule would dictate that inventoryrule would dictate that inventory

be recorded at Cost.be recorded at Cost.

LCM - Example


#et $eali%able&alue less #ormal

Pro!it ')loor(



In this case, market value will beIn this case, market value will be

89?.@, because the89?.@, because the

relacement cost is between therelacement cost is between the

ceilin" and the !loor.ceilin" and the !loor.

In this case, market value will beIn this case, market value will be

89?.@, because the89?.@, because the

relacement cost is between therelacement cost is between the

ceilin" and the !loor.ceilin" and the !loor.



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9-9

LCM - Another Example

An inventory item is currently carried atAn inventory item is currently carried athistorical cost o! 8B@. er unit. At thehistorical cost o! 8B@. er unit. At the

alance =heet date we "ather thealance =heet date we "ather the!ollowin" er unit in!ormation: current!ollowin" er unit in!ormation: current

relacement cost 6 8.D #$& 6relacement cost 6 8.D #$& 68?.D and #$& reduced by normal8?.D and #$& reduced by normal

ro!it 6 [email protected]!it 6 8@..

An inventory item is currently carried atAn inventory item is currently carried athistorical cost o! 8B@. er unit. At thehistorical cost o! 8B@. er unit. At the

alance =heet date we "ather thealance =heet date we "ather the!ollowin" er unit in!ormation: current!ollowin" er unit in!ormation: current

relacement cost 6 8.D #$& 6relacement cost 6 8.D #$& 68?.D and #$& reduced by normal8?.D and #$& reduced by normal

ro!it 6 [email protected]!it 6 8@..



Slide

9-10 Lower of Cost or Market

Another Example


')loor( 6 8@

#et $eali%able &alue'Ceilin"( 6 8?

$elacementCost 68

$elacementCost 68

?

?

?

hich one dowe use as

market value>

hich one dowe use as

market value>



Slide

9-11 Lower of Cost or Market

Another Example

Should the inventor !e carried at"ar#et alue or %ost&

Should the inventor !e carried at"ar#et alue or %ost&

"ar#et = $'5 ( %ost = $)5

*ur inventor item +ill !e +rittendo+n to the "ar#et alue $'5.

"ar#et = $'5 ( %ost = $)5

*ur inventor item +ill !e+rittendo+nto the "ar#et alue $'5.


')loor( 6 8@

#et $eali%able &alue'Ceilin"( 6 8?

$elacementCost 68

$elacementCost 68



Slide

9-12

1. ,ppl -%" to1. ,ppl -%" to each individual itemeach individual iteminin

inventor.inventor.

1. ,ppl -%" to1. ,ppl -%" to each individual itemeach individual iteminin

inventor.inventor.2. ,ppl -%" to each2. ,ppl -%" to each classclassof inventor.of inventor.2. ,ppl -%" to each2. ,ppl -%" to each classclassof inventor.of inventor.3. ,ppl -%" to the3. ,ppl -%" to the entireentireinventor as ainventor as a

group.group.

3. ,ppl -%" to the3. ,ppl -%" to the entireentireinventor as ainventor as a

group.group.

Applying LCM

-%" can !e applied 3 different +as.



Slide

9-13 A!usting Cost to Market -

"ptions

$ecord the Loss as a =earateItem in the Income =tatement

,dust inventor directl or using anallo+ance account.

$ecord the Loss as art o! C*G= ,dust inventor directl or using an

allo+ance account.

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9-14

#n$entory Estimation %e&hni'ues

Estimate instead o! takin"hysical inventory

-ess costl -ess time consuming

+wo oular methods are . . .

/ross rofit "ethod etail nventor "ethod

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9-15

ross rofit Metho

1se!ulwhen . . .

1se!ulwhen . . .

Estimatin" inventoryF C*G= !or interim

reorts.

Estimatin" inventoryF C*G= !or interim

reorts.

3eterminin" the

cost o! inventorylost, destroyed, or

stolen.

3eterminin" the

cost o! inventorylost, destroyed, or

stolen.

Auditors are testin"the overall

reasonableness o!

client inventories.

Auditors are testin"the overall

reasonableness o!client inventories.

Prearin" bud"etsand !orecasts.

Prearin" bud"etsand !orecasts.

#*+E: +he Gross Pro!it Method is not acceted by GAAP.#*+E: +he Gross Pro!it Method is not acceted by GAAP.

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9-16

ross rofit Metho

Assumes that the historical "ross mar"inrate is reasonably constant in the short run.

Assumes that the historical "ross mar"inrate is reasonably constant in the short run.

Cost o! be"innin"inventory.

Cost o! be"innin"inventory.

#et urchases !orthe eriod.

#et urchases !orthe eriod.


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Slide

9-17

*teps to the ross rofit Metho

?. Estimate historical Gross Mar"in .

9. =ales H '? ; Estimated Gross Mar"in

( 6 Estimated C*G=. e". Inventory #et Purchases 6

Cost o! Goods Available !or =ale'C*GA=(

-. Estimated C*G= ; C*GA= 6Estimated Cost o! Endin" Inventory

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Slide

9-18 ross rofit Metho

Example

#oteCo, Inc. uses the "ross ro!it method toestimate end o! month inventory. At the endo! May, the controller has the !ollowin" data:

#et sales !or May 6 8?,9?,D

#et urchases !or May 6 8J9,D

Inventory at May ? 6 89J,-DGross mar"in 6 - o! sales.

Estimate Inventory at May ?.Estimate Inventory at May ?.

#oteCo, Inc. uses the "ross ro!it method toestimate end o! month inventory. At the endo! May, the controller has the !ollowin" data:

#et sales !or May 6 8?,9?,D

#et urchases !or May 6 8J9,DInventory at May ? 6 89J,-DGross mar"in 6 - o! sales.

Estimate Inventory at May ?.Estimate Inventory at May ?.

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Slide

9-19 ross rofit Metho

Example

#*+E: +he key to success!ully alyin" thismethod is a reliable Gross Mar"in .

#*+E: +he key to success!ully alyin" thismethod is a reliable Gross Mar"in .

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9-20

+etail #n$entory Metho

+his method was develoed !or retailoerations like deartment stores.

1ses both the retail value and cost o!items !or sale to calculate a cost toretail ratio.

*bKective: Convert endin"*bKective: Convert endin"

inventory at retail to endin"inventory at retail to endin"

inventory at cost.inventory at cost.

*bKective: Convert endin"*bKective: Convert endin"inventory at retail to endin"inventory at retail to endin"

inventory at cost.inventory at cost.

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9-21

+etail #n$entory Metho

e need toknow . . .

e need toknow . . .

=ales !or theeriod.

=ales !or theeriod.

e"innin"inventory at retail

and cost.

e"innin"inventory at retail

and cost.

AdKustments to theori"inal retail rice.

AdKustments to theori"inal retail rice.

#et urchases atretail and cost.

#et urchases atretail and cost.

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Slide

9-22 *teps to the +etail #n$entory

Metho

?. 3etermine cost and retail value o! "oodssold.

9. Calculate the cost;to;retail .. $etail value o! "oods available !or sale ;

sales 6 endin" inventory at retail.

-. Cost;to;retail H Endin" inventory atretail 6 Estimated endin" inventory atcost.

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9-23 +etail #n$entory Metho

Example

ebb Clothiers, Inc. uses the retail method toestimate inventory at the end o! each month. )or

the month o! May the controller "athers the!ollowin" in!ormation:

e". inventory at cost 89J, 'at retail8-@,(, net urchases at cost 8?, 'at

retail 8,(D net sales !or May 8?,.

Estimate the inventory at May ?.

ebb Clothiers, Inc. uses the retail method toestimate inventory at the end o! each month. )or

the month o! May the controller "athers the!ollowin" in!ormation:

e". inventory at cost 89J, 'at retail8-@,(,net urchases at cost 8?, 'at

retail 8,(Dnet sales !or May 8?,.

Estimate the inventory at May ?.

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Example

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Example

H

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S de

9-26

Approximating A$erage Cost

+he rimary di!!erencebetween this and our earlier,

simli!ied eHamle, is theinclusion o! markus and

markdowns in the comutationo! the Cost;to;$etail .

+he rimary di!!erencebetween this and our earlier,

simli!ied eHamle, is theinclusion o! markus and

markdowns in the comutationo! the Cost;to;$etail .

Slide

il h


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A$erage Cost Example

ebb, Inc. uses the avera"e cost retail method toestimate inventory at the end o! une. +he

controller "athers the !ollowin" in!ormation:

e"innin" inventory at cost 89?, 'at retail8@,(, net urchases at cost 89, 'at

retail 8-,(, net markus 8,, net

markdowns 8-,, and net sales !or une8,.

Estimate inventory at une .



e"innin" inventory at cost 89?, 'at retail8@,(,net urchases at cost 89, 'at

retail 8-,(,net markus 8,, net

markdowns 8-,,and net sales !or une8,.

Estimate inventory at une .

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il h


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il h


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H

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+ il # M h


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A$erage LCM

AroHimatin" Avera"e LCM

#et Markdowns are

eHcluded in thecomutation o! theCost;to;$etail

#et Markdowns are

eHcludedin thecomutation o! theCost;to;$etail

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+ il # M h


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A$erage LCM Example



e"innin" inventory at cost 89?, 'at retail8@,(, net urchases at cost 89, 'at

retail 8-,(, net markus 8,, net

markdowns 8-,, and net sales !or une8,.

Lets estimate inventory at une .



e"innin" inventory at cost 89?, 'at retail8@,(,net urchases at cost 89, 'at

retail 8-,(,net markus 8,, net

markdowns 8-,,and net sales !or une8,.

Lets estimate inventory at une .

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+ il # M h


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A$erage LCM Example

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+ il # M h


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A$erage LCM Example

H

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9-34

%he L#," +etail Metho

Assume that retail rices o! "oodsremain stable durin" the eriod.

Establish a LI)* base layer'be"innin" inventory( and add 'orsubtract( the layer !rom the currenteriod.

Calculate the cost;to;retailercenta"e !or be"innin" inventoryand !or adKusted net urchases !orthe eriod.

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9-35

%he L#," +etail Metho

e"innin" inventory has its owncost;to;retail ercenta"e.

e"innin" inventory has its owncost;to;retail ercenta"e.

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9 36 %h L#," + t il M th


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9-36 %he L#," +etail Metho

Example

1se the data !rom ebb Inc. to estimatethe LI)* endin" inventory. eginning inventor at cost $21000 at retail

$35000; et purchases at cost $200000 at retail

$304000; et mar#ups $'000;

et mar#do+ns $4000; et sales for 6une $300000.

Estimate endin" inventory.

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9 37 %h L#," + t il M th


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9-37 %he L#," +etail Metho

Example

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9-38

"thers #ssues of +etail Metho

Purchase returns and urchasediscounts.

)rei"ht;in.Emloyee discounts.

=oila"e, breaka"e, and the!t.

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9-39

Dollar-Value L#," +etail

e need to eliminate the e!!ect o! anyrice chan"es be!ore we comare

the endin" inventory with thebe"innin" inventory.

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9 40 D ll V l L#," + t il


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9-40 Dollar-Value L#," +etail

Example

7se the data from 8e!! nc. to estimate the -9*ending inventor.

e"innin" inventory at cost 89?,, at retail8@,D

#et urchases at cost 89,, at retail 8-,D

#et markus 8,D #et markdowns 8-,D

#et sales !or une 8,.

rice inde: at 6une 1 is 100 and at 6une 30 the inde:is 102. stimate ending inventor.

7se the data from 8e!! nc. to estimate the -9*ending inventor.

e"innin" inventory at cost 89?,, at retail8@,D

#et urchases at cost 89,, at retail 8-,D

#et markus 8,D #et markdowns 8-,D

#et sales !or une 8,.

rice inde: at 6une 1 is 100 and at 6une 30 the inde:is 102. stimate ending inventor.

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9 41 D ll V l L#," + t il


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9-41 Dollar-Value L#," +etail

Example

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9-42


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9-42

Changes in #n$entory Metho

Chan"es not involvin" LI)* eport the cumulative effect of the change net of

ta: on the current income statement.

Chan"es to LI)* !rom other methods 7suall impossi!le to determine the cumulative

effect.

Chan"es !rom LI)* to other methods etroactivel restate financial statements for each

ear reported.


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9 45

#n$entory Errors

*verstatement o! urchases *verstates cost of goods sold and

7nderstates preta: income.1nderstatement o! urchases 7nderstates cost of goods sold and

*verstates preta: income.

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En of Chapter 9

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Inventory Additional Issues

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