Inventories: Additional Issues Chapter 9

Reporting —Lower of Cost or Market Inventories are valued at the lower of cost or market (LCM). LCM is a departure from historical cost. The method causes losses to be recognized in the period the value of inventory declines below its cost rather than in the period that the goods ultimately are sold.

Determining Market Value Market Should Not Exceed Net Realizable Value (Ceiling) Market Should Not Be Less Than Net Realizable Value less Normal Profit (Floor)  GAAP defines “market value” in terms of current replacement cost.  Market should not be greater than the “ceiling” or less than the “floor.”  GAAP defines “market value” in terms of current replacement cost.  Market should not be greater than the “ceiling” or less than the “floor.”

Determining Market Value Ceiling NRV Replacement Cost NRV – NP Floor Designated Market CostCost Not More Than Not Less Than Or Step 1 Determine Designated Market Step 2 Compare Designated Market with Cost Lower of Cost or Market

 An item in inventory has a historical cost of $20 per unit. At year-end we gather the following per unit information: Current replacement cost = $21.50 Selling price = $30 Cost to complete and dispose = $4 Normal profit margin = $5  How would we value this item in the balance sheet?

Lower of Cost or Market Replacement Cost =$21.50 Replacement Cost =$21.50 $21.50 Designated Market? Historical cost of $20.00 is less than designated market of $21.50, so this inventory item will be valued at cost of $20.00.

1. Apply LCM to each individual item in inventory such as printers. Applying Lower of Cost or Market Lower of cost or market can be applied 3 different ways.

1. Apply LCM to each individual item in inventory. 2. Apply LCM to logical inventory categories, such as desktop and laptop computers. Applying Lower of Cost or Market Lower of cost or market can be applied 3 different ways.

1. Apply LCM to each individual item in inventory. 2. Apply LCM to logical inventory categories. 3. Apply LCM to the entire inventory as a group. Applying Lower of Cost or Market Lower of cost or market can be applied 3 different ways.

Adjusting Cost to Market 1. Record the loss as a separate item in the income statement Loss on write-down of inventory XX Inventory XX 2. Record the loss as part of cost of goods sold. Cost of goods sold XX Inventory XX

U. S. GAAP vs. IFRS Inventory is valued at the lower of cost or market with market selected from replacement cost, net realizable value or NRV reduced by the normal profit margin. Designated market is compared to historical cost to determine LCM. The LCM rule can be applied to individual items, logical inventory categories, or the entire inventory. Reversals are not permitted. Inventory is valued at the lower or cost of market and net realizable value. The assessment usually is applied to individual items, although using logical inventory categories is allowed under certain circumstances. If an inventory write-down is no longer appropriate, it must be reversed. International and U.S. standards for valuing inventory at the lower of cost or market are slightly different.

Inventory Estimation Techniques (NOT COVERED) Estimate instead of taking physical inventory 1. Less costly 2. Less time-consuming Two popular methods of estimating ending inventory are the Gross profit method 2. Retail inventory method

End of Chapter 9