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Chapter 9-1. Chapter 9-2 C H A P T E R 9 INVENTORIES: ADDITIONAL VALUATION ISSUES Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield.

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Presentation on theme: "Chapter 9-1. Chapter 9-2 C H A P T E R 9 INVENTORIES: ADDITIONAL VALUATION ISSUES Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield."— Presentation transcript:

1 Chapter 9-1

2 Chapter 9-2 C H A P T E R 9 INVENTORIES: ADDITIONAL VALUATION ISSUES Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield

3 Chapter Describe and apply the lower-of-cost-or-market rule. 2.Explain when companies value inventories at net realizable value. 3.Explain when companies use the relative sales value method to value inventories. 4.Discuss accounting issues related to purchase commitments. 5.Determine ending inventory by applying the gross profit method. 6.Determine ending inventory by applying the retail inventory method. 7.Explain how to report and analyze inventory. Learning Objectives

4 Chapter 9-4 Net realizable value Relative sales value Purchase commitments Lower-of- Cost-or- Market Valuation Bases Gross Profit Method Retail Inventory Method Presentation and Analysis Ceiling and floor How LCM works Application of LCM “Market” “Market” Evaluation of rule Gross profit percentage Evaluation of method Concepts Conventional method Special items Evaluation of method PresentationAnalysis Inventories: Additional Valuation Issues

5 Chapter 9-5 Market = Replacement Cost Lower of Cost or Replacement Cost Loss should be recorded when loss occurs, not in the period of sale. A company abandons the historical cost principle when the future utility (revenue-producing ability) of the asset drops below its original cost. Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. LCM

6 Chapter 9-6 Decline in the RC usually = decline in selling price. RC allows a consistent rate of gross profit. If reduction in RC fails to indicate reduction in utility, then two additional valuation limitations are used:  Ceiling - net realizable value and  Floor - net realizable value less a normal profit margin. Why use Replacement Cost (RC) for Market? Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. Ceiling and Floor

7 Chapter 9-7 Not< Cost Market Ceiling = NRV Replacement Cost Replacement Cost Floor = NRV less Normal Profit Margin Floor = NRV less Normal Profit Margin GAAP LCM GAAP LCM What is the rationale for the Ceiling and Floor limitations? Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. Not> Illustration 9-3

8 Chapter 9-8 Ceiling – prevents overstatement of the value of obsolete, damaged, or shopworn inventories. Floor – deters understatement of inventory and overstatement of the loss in the current period. Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. Rationale for Limitations

9 Chapter 9-9 Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. How LCM Works (Individual Items) Illustration 9-5 Solution on notes page

10 Chapter 9-10 Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. Methods of Applying LCM Illustration 9-6 Solution on notes page

11 Chapter 9-11 LO 1 Describe and apply the lower-of-cost-or-market rule. Lower-of-Cost-or-MarketLower-of-Cost-or-Market Recording LCM (data from Illus. 9-5 and 9-6) Ending inventory (cost) $ 415,000 Ending inventory (LCM)350,000 Adjustment to LCM $ 65,000 Allowance on inventory 65,000 Loss on inventory65,000 Inventory 65,000 Cost of goods sold65,000 Allowance Method Allowance Method Direct Method Direct Method

12 Chapter 9-12 LO 1 Describe and apply the lower-of-cost-or-market rule. Lower-of-Cost-or-MarketLower-of-Cost-or-Market Balance Sheet Presentation

13 Chapter 9-13 LO 1 Describe and apply the lower-of-cost-or-market rule. Lower-of-Cost-or-MarketLower-of-Cost-or-Market Income Statement Presentation

14 Chapter 9-14 P9-1: KC Company manufactures desks. The company attempts to obtain a 20% gross margin on selling price. At December 31, 2010, the following finished desks appear in the company’s inventory. Instructions: At what amount should the desks appear in the company’s December 31, 2010, inventory, assuming that the company has adopted a lower-of-FIFO-cost-or-market approach for valuation of inventories on an individual-item basis? Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule.

15 Chapter 9-15 Not< Cost = 470 Market = 450 Ceiling = 450 (500 – 50) Ceiling = 450 (500 – 50) Replacement Cost = 460 Replacement Cost = 460 Floor = 350 (450-(500 x 20%)) Floor = 350 (450-(500 x 20%)) LCM = 450 Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. Not>

16 Chapter 9-16 Not< Cost = 450 Market = 430 Ceiling = 480 (540 – 60) Ceiling = 480 (540 – 60) Replacement Cost = 430 Replacement Cost = 430 Floor = 372 (480-(540 x 20%)) Floor = 372 (480-(540 x 20%)) LCM = 430 Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. Not>

17 Chapter 9-17 Not< Cost = 830 Market = 640 Ceiling = 820 (900 – 80) Ceiling = 820 (900 – 80) Replacement Cost = 610 Replacement Cost = 610 Floor = 640 (820-(900 x 20%)) Floor = 640 (820-(900 x 20%)) LCM = 640 Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. Not>

18 Chapter 9-18 Not< Cost = 960 Market = 1,000 Ceiling = 1,070 (1,200 – 130) Ceiling = 1,070 (1,200 – 130) Replacement Cost = 1,000 Replacement Cost = 1,000 Floor = 830 (1,070-(1,200 x 20%)) Floor = 830 (1,070-(1,200 x 20%)) LCM = 960 Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. Not>

19 Chapter 9-19 Expense recorded when loss in utility occurs. Profit on sale recognized at the point of sale. Inventory valued at cost in one year and at market in the next year. Net income in year of loss is lower. Net income in subsequent period may be higher than normal if expected reductions in sales price do not materialize. LCM uses a “normal profit” in determining inventory values, which is a subjective measure. Some Deficiencies: Lower-of-Cost-or-MarketLower-of-Cost-or-Market LO 1 Describe and apply the lower-of-cost-or-market rule. Evaluation of LCM Rule

20 Chapter 9-20 (1)a controlled market with a quoted price applicable to all quantities, and (2)no significant costs of disposal (rare metals and agricultural products) or (3)too difficult to obtain cost figures (meatpacking) Permitted by GAAP under the following conditions: Valuation Bases LO 2 Explain when companies value inventories at net realizable value. Net Realizable Value

21 Chapter 9-21 Used when buying varying units in a single lump-sum purchase. Valuation Bases LO 3 Explain when companies use the relative sales value method to value inventories. Relative Sales Value E9-7: Larsen Realty Corporation purchased a tract of unimproved land for $55,000. This land was improved and subdivided into building lots at an additional cost of $30,000. These building lots were all of the same size but owing to differences in location were offered for sale at different prices as follows. Operating expenses allocated to this project total $18,200. Instructions: Calculate the net income realized on this operation to date.

22 Chapter 9-22 Valuation Bases LO 3 Explain when companies use the relative sales value method to value inventories. E9-7 (Relative Sales Value Method - Solution) x=x = = x

23 Chapter 9-23 Generally seller retains title to the merchandise. Buyer recognizes no asset or liability. If material, the buyer should disclose contract details in footnote. If the contract price is greater than the market price, and the buyer expects that losses will occur when the purchase is effected, the buyer should recognize losses in the period during which such declines in market prices take place. Valuation Bases LO 4 Discuss accounting issues related to purchase commitments. Purchase Commitments

24 Chapter 9-24 Valuation Bases LO 4 Discuss accounting issues related to purchase commitments. Illustration: St. Regis Paper Co. signed timber-cutting contracts to be executed in 2012 at a price of $10,000,000. Assume further that the market price of the timber cutting rights on December 31, 2011, dropped to $7,000,000. St. Regis would make the following entry on December 31, Unrealized Holding Gain or Loss—Income3,000,000 Estimated Liability on Purchase Commitments 3,000,000

25 Chapter 9-25 Valuation Bases LO 4 Discuss accounting issues related to purchase commitments. Illustration: When St. Regis cuts the timber at a cost of $10 million, it would make the following entry. Purchases (Inventory) 7,000,000 Estimated Liability 3,000,000 Cash 10,000,000 If Congress permitted St. Regis to reduce its contract price and therefore its commitment by $1,000,000. Estimated Liability 1,000,000 Unrealized Holding Gain or Loss—Income1,000,000

26 Chapter 9-26 Relies on Three Assumptions: Gross Profit Method LO 5 Determine ending inventory by applying the gross profit method. Substitute Measure to Approximate Inventory (1)Beginning inventory plus purchases equal total goods to be accounted for. (2)Goods not sold must be on hand. (3)The sales, reduced to cost, deducted from the sum of the opening inventory plus purchases, equal ending inventory.

27 Chapter 9-27 Gross Profit Method LO 5 Determine ending inventory by applying the gross profit method. Illustration: Cetus Corp. has a beginning inventory of $60,000 and purchases of $200,000, both at cost. Sales at selling price amount to $280,000. The gross profit on selling price is 30 percent. Cetus applies the gross margin method as follows. Illustration 9-13

28 Chapter 9-28 Gross Profit Method LO 5 Determine ending inventory by applying the gross profit method. Computation of Gross Profit Percentage Illustration 9-16

29 Chapter 9-29 E9-12: Astaire Company uses the gross profit method to estimate inventory for monthly reporting purposes. Presented below is information for the month of May. Instructions: (a) Compute the estimated inventory at May 31, assuming that the gross profit is 25% of sales. (b) Compute the estimated inventory at May 31, assuming that the gross profit is 25% of cost. Gross Profit Method LO 5 Determine ending inventory by applying the gross profit method.

30 Chapter 9-30 E9-12 (Solution): (a) Compute the estimated inventory assuming gross profit is 25% of sales. Gross Profit Method LO 5 Determine ending inventory by applying the gross profit method.

31 Chapter 9-31 (b) Compute the estimated inventory assuming gross profit is 25% of cost. Gross Profit Method LO 5 Determine ending inventory by applying the gross profit method. 25% 100% + 25% = 20% of sales E9-12 (Solution):

32 Chapter 9-32 Disadvantages: Gross Profit Method LO 5 Determine ending inventory by applying the gross profit method. Evaluation: (1)Provides an estimate of ending inventory. (2)Uses past percentages in calculation. (3)A blanket gross profit rate may not be representative. (4)Only acceptable for interim (generally quarterly) reporting purposes.

33 Chapter 9-33 Retail Inventory Method LO 6 Determine ending inventory by applying the retail inventory method. A method used by retailers, to value inventory without a physical count, by converting retail prices to cost. (1)the total cost and retail value of goods purchased, (2)the total cost and retail value of the goods available for sale, and (3)the sales for the period. Requires retailers to keep:

34 Chapter 9-34 P9-8: Fuque Inc. uses the retail inventory method to estimate ending inventory for its monthly financial statements. The following data pertain to a single department for the month of October Retail Inventory Method Instructions: Prepare a schedule computing estimate retail inventory using the following methods: (1) Cost (2) LCM (3) LIFO (appendix) LO 6 Determine ending inventory by applying the retail inventory method.

35 Chapter 9-35 Retail Inventory - Cost Method LO 6 Determine ending inventory by applying the retail inventory method. =/

36 Chapter 9-36 Retail Inventory - LCM Method LO 6 Determine ending inventory by applying the retail inventory method. = /

37 Chapter 9-37 Retail Inventory - LIFO Method LO 8 Determine ending inventory by applying the LIFO retail inventory methods. = / = / Appendix 9A

38 Chapter 9-38 Special Items Retail Inventory Method LO 6 Determine ending inventory by applying the retail inventory method.  Freight costs  Purchase returns  Purchase discounts and allowances  Transfers-in  Normal spoilage  Abnormal shortages  Employee discounts

39 Chapter 9-39 Widely used for the following reasons: Evaluation: (1)to permit the computation of net income without a physical count of inventory, (2)as a control measure in determining inventory shortages, (3)in regulating quantities of merchandise on hand, and (4)for insurance information. Retail Inventory Method LO 6 Determine ending inventory by applying the retail inventory method. Some companies refine the retail method by computing inventory separately by departments or class of merchandise with similar gross profits.

40 Chapter 9-40 Accounting standards require disclosure of: Presentation and Analysis LO 7 Explain how to report and analyze inventory. Presentation: (1)composition of the inventory, (2)financing arrangements, and (3)costing methods employed. Common ratios used in the management and evaluation of inventory levels are inventory turnover and average days to sell the inventory. Analysis:

41 Chapter 9-41 Measures the number of times on average a company sells the inventory during the period. Presentation and Analysis LO 7 Explain how to report and analyze inventory. Inventory Turnover Ratio Illustration 9-26

42 Chapter 9-42 Measure represents the average number of days’ sales for which a company has inventory on hand. Presentation and Analysis LO 7 Explain how to report and analyze inventory. Average Days to Sell Inventory 365 days / 7.5 times = every 48.7 days Average Days to Sell Illustration 9-26

43 Chapter 9-43  U.S. GAAP permits the use of LIFO for inventory valuation. iGAAP prohibits its use.  In the lower-of-cost-or-market test for inventory valuation, iGAAP defines market as net realizable value. U.S. GAAP defines market as replacement cost subject to the constraints.  In U.S. GAAP, inventory written down under the lower-of-cost-or- market valuation may not be written back up to its original cost in a subsequent period. Under iGAAP, the write-down may be reversed in a subsequent period.

44 Chapter 9-44 LO 8 Determine ending inventory by applying the LIFO retail methods. Primary reason to use LIFO Tax advantages. Results in a better matching of costs and revenues. The use of LIFO retail is made under two assumptions: 1.stable prices and 2.fluctuating prices.

45 Chapter 9-45 LO 8 Determine ending inventory by applying the LIFO retail methods. Stable Prices—LIFO Retail Method A major assumption of the LIFO retail method is that the markups and markdowns apply only to the goods purchased during the current period and not to the beginning inventory. Beginning inventory is excluded from the cost-to-retail percentage.

46 Chapter 9-46 LO 8 Determine ending inventory by applying the LIFO retail methods. ILLUSTRATION 9A-1 LIFO Retail Method—Stable Prices

47 Chapter 9-47 LO 8 Determine ending inventory by applying the LIFO retail methods. ILLUSTRATION 9A-2 Ending Inventory at LIFO Cost, 2010—Stable Prices Inventory is composed of two layers. Solution on notes page

48 Chapter 9-48 LO 8 Determine ending inventory by applying the LIFO retail methods. ILLUSTRATION 9A-3 Ending Inventory at LIFO Cost, 2011—Stable Prices Assume that the ending inventory for 2011 at retail is $50,000. Notice that the 2010 layer is reduced from $11,000 to $5,000. Solution on notes page

49 Chapter 9-49 LO 8 Determine ending inventory by applying the LIFO retail methods. Fluctuating Prices—Dollar-Value LIFO Retail If the price level does change, the company must eliminate the price change so as to measure the real increase in inventory, not the dollar increase.

50 Chapter 9-50 LO 8 Determine ending inventory by applying the LIFO retail methods. Illustration: Assume that the beginning inventory had a retail market value of $10,000 and the ending inventory had a retail market value of $15,000. Assume further that the price level has risen from 100 to 125. It is inappropriate to suggest that a real increase in inventory of $5,000 has occurred. Instead, the company must deflate the ending inventory at retail. Illustration 9A-4

51 Chapter 9-51 LO 8 Determine ending inventory by applying the LIFO retail methods. Illustration: Assume that the current 2010 price index is 112 (prior year 100) and that the inventory ($56,000) has remained unchanged. Illustration 9A-5 Dollar-Value LIFO Retail Method— Fluctuating Prices

52 Chapter 9-52 LO 8 Determine ending inventory by applying the LIFO retail methods. Illustration: From this information, we compute the inventory amount at cost: Illustration 9A-6 Hernandez must restate layers of a particular year to the prices in effect in the year when the layer was added.

53 Chapter 9-53 LO 8 Determine ending inventory by applying the LIFO retail methods. Illustration 9A-7 Comparison of Effect of Price Assumptions

54 Chapter 9-54 LO 8 Determine ending inventory by applying the LIFO retail methods. Illustration: Using the data from the previous example, assume that the retail value of the 2011 ending inventory at current prices is $64,800, the 2011 price index is 120 percent of base-year, and the cost-to-retail percentage is 75 percent. Compute the ending inventory at LIFO cost. Illustration 9A-8 Subsequent Adjustments under Dollar-Value LIFO Retail

55 Chapter 9-55 LO 8 Determine ending inventory by applying the LIFO retail methods. Illustration: Conversely assume that in 2011 the ending inventory in base-year prices is $48,000. Compute the ending inventory at LIFO cost. Illustration 9A-9 Subsequent Adjustments under Dollar-Value LIFO Retail

56 Chapter 9-56 LO 8 Determine ending inventory by applying the LIFO retail methods. Changing from Conventional Retail to LIFO Illustration: Clark Clothing Store employs the conventional retail method but wishes to change to the LIFO retail method beginning in The amounts shown by the firm’s books are as follows.

57 Chapter 9-57 Conventional Retail Inventory Method Illustration 9A-10

58 Chapter 9-58 Illustration 9A-11 Clark Clothing can then quickly approximate the ending inventory for 2010 under the LIFO retail method. The difference of $500 ($11,250 - $10,750) between the LIFO retail method and the conventional retail method is the amount by which the company must adjust beginning inventory for LO 8 Determine ending inventory by applying the LIFO retail methods.

59 Chapter 9-59 Copyright © 2009 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. CopyrightCopyright


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