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Chapter 9 Inventories: Additional Valuations Issues ACCT-30301.

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Presentation on theme: "Chapter 9 Inventories: Additional Valuations Issues ACCT-30301."— Presentation transcript:

1 Chapter 9 Inventories: Additional Valuations Issues ACCT-30301

2 1. Lower of Cost or Market Required by GAAP* ◦ Inventory must be reported at LCM Theory ◦ should not report inventory at a value higher than benefits to be received from selling it Stated reason: “conservative approach” ACCT-30302

3 1a. Lower of Cost or Market Definition of market ◦ cost to replace the item (replacement cost) ◦ really “lower of cost or constrained market” Ceiling ◦ market can’t exceed NRV ◦ NRV = selling price – selling costs Floor ◦ market can’t be lower than NRV less normal profit ◦ floor = NRV – normal profit margin Can apply to individual items, groups of items, or whole inventory Does not apply to damaged or deteriorated goods ACCT-30303

4 1b. Lower of Cost or Market Example Selling price$60 Additional selling costs$10 Normal profit margin40% (of selling price) Cost$36 Current replacement cost Case A$58 Case B$37 Case C$21 ACCT-30304

5 1c. Other Valuation Bases Valuation at Net Realizable Value ◦ e.g., recognizing revenue at completion of production Valuation using Relative Sales Value ◦ basket purchase ◦ meat-packing plant ACCT-30305

6 2. Purchase Commitments Generally seller retains title to merchandise Buyer recognizes no asset or liability If material, the buyer should disclose contract details in footnote If contract price > the market price, and buyer expects that losses will occur when purchase made ◦ buyer should recognize liability and corresponding loss in period when market declined Omit Hedging ACCT-30306

7 3. Inventory Estimation Methods Gross profit method ◦ based on relationship between sales and gross profit ◦ not acceptable for financial reporting or taxes Retail method ◦ used by large volume retailers ◦ dollar based method – not unit based method ◦ acceptable for financial reporting and taxes ACCT-30307

8 4. Gross Profit Method Based on assumptions that ◦ gross profit is constant from period-to-period ◦ sales mix of products is constant Used to estimate inventory value ACCT-30308

9 4a. Gross Profit Method Example Sales$200 Cost of goods sold$120 Gross profit$ 80 GP % = 80/200 = 40% CGS% = 120/200 = 60% GP% on sales = 80/200 = 40% GP% on cost = 80/120 = 66⅔% ACCT GP on Sales = GP on Costs 1 + GP on Costs

10 4a. Gross Profit Method Example A hurricane destroyed the entire inventory stored in a warehouse. The following information is available from the company’s records. Beginning inventory$220,000 Purchases$400,000 Sales$600,000 Historical gross profit rate 30% Required: Estimate the cost of the destroyed inventory. ACCT

11 4a. Gross Profit Method Example — Solution Beginning inventory (from records) $220,000 Plus: Net purchases (from records) 400,000 Cost of goods available for sale 620,000 Less: Cost of goods sold: Net sales$600,000 Less: Estimated gross profit of 30%(180,000) Estimated cost of goods sold (420,000) Estimated cost of inventory destroyed $200,000 ACCT

12 5. Retail Method Method is based on the pattern between the cost and retail value of the goods Method requires: 1.total costs of goods purchased 2.total retail value of goods available for sale 3.total sales Companies always keep 1 & 3 ◦ with this method also must keep 2 ACCT

13 5a. Retail Method Basic method ACCT CostRetail Beginning Inventory6001,000 Net Purchases5,0008,000 Goods Available for Sale5,6009,000 Cost Ratio: 5,600/9,000 = Sales7,500 Ending Inventory at Retail1,500 End Inv at Cost (1,500 x.62222) 933

14 5c. Retail Method Retail terminology ACCT TermMeaning Initial markupOriginal markup reflected in sales price Additional markupAdditional increase in selling price after original markup Markup cancellationElimination of additional markup MarkdownReduction in selling price below original selling price Markdown cancellationElimination of markdown Net markups and net markdowns

15 5b. Retail Method Ratios – computed as: cost of goods available for sale retail value of goods available for sale Based on how ratio computed, can be used to approximate following methods: ◦ average – include everything ◦ LCM – exclude markdowns (conventional retail method) ◦ FIFO – exclude beginning inventory ◦ LIFO – compute separate ratio for each layer ACCT

16 5d. Retail Method ACCT CostRetail Beginning Inventory++ Purchases++ Purchases Returns-- Purchases Discounts- Freight-In+ Net Markups+ Net Markdowns- Available for SaleXX Sales- Sales Returns and Allow.+ Sales Discounts+ Ending Inventory at RetailX Ending Inventory at CostX

17 5e. Retail Method ACCT CostRetail Beginning Inventory++ Purchases++ Purchases Returns and Allow.-- Purchases Discounts- Freight-In+ Net Markups+ Net Markdowns- Available for SaleXX Sales- Sales Returns and Allow.+ Sales Discounts+ Ending Inventory at RetailX Ending Inventory at CostX Avg. method

18 5f. Retail Method ACCT CostRetail Beginning Inventory++ Purchases++ Purchases Returns and Allow.-- Purchases Discounts- Freight-In+ Net Markups+ Net Markdowns- Available for SaleXX Sales- Sales Returns and Allow.+ Sales Discounts+ Ending Inventory at RetailX Ending Inventory at CostX LCM method

19 5g. Retail Method ACCT CostRetail Beginning Inventory++ Purchases++ Purchases Returns and Allow.-- Purchases Discounts- Freight-In+ Net Markups+ Net Markdowns- Available for SaleXX Sales- Sales Returns and Allow.+ Sales Discounts+ Ending Inventory at RetailX Ending Inventory at CostX FIFO method

20 5h. Retail Method ACCT CostRetail Beginning Inventory195,000400,000 Net Purchases300,000450,000 Net Markups50,000 Net Markdowns Available for Sale495,000880,000 Net Sales407,000 Ending Inventory at Retail473,000 Ending Inventory at Cost Example


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