1. Inventories – Additional Issues
Main Issues:
Lower of Cost or Market
Estimation Techniques
Inventory Errors
LCM
Impaired inventory
Basis is on market given by current replacement cost bounded by NRV and NRV – Normal profit
NRV – NP < RC < NRV
NRV = Selling price – Est.. Disposal cost
NP = Profit Margin * Selling price
Take the lower of cost or RC
Inventory Estimation Techniques

2. Inventory Estimation Techniques
Why do we estimate?
Data lost to unforeseen circumstances – fire, insurance
F/S needed during the year and physical inventory not available
Auditor testing for reasonableness
Forecasting and budgeting
Two methods:
Gross method
Easy. We know sales, Gross Profit ratio (or mark-up, beg. Inventory and purchases
Accurate estimates is dependent on the reliability of the GP ratio.
Retail inventory method- next slide

3. Inventory Estimation -Retail Inventory Method
Used primarily by retail companies
Need CGAS at retail prices (current SP) – must track inventory and purchases at cost and at SP
At retail prices BIr + Pr – Sales = EIr
where CGASr = BIr + Pr
At cost BIc + Pc – CGS = EIc (unknown)
where CGASc = BIc + Pc
Cost to retail % = CGASc / CGASr
Hence, EIc = EIr * CGASc / CGASr
Advantages: 1) Allowed by IRS 2) Acceptable for external reporting 3) Method allows different cost flow methods eg. LIFO , Avg cost, FIFO

4. Inventory Estimation -Retail Inventory Method
Allows selling price to change over time – changes in markups and markdowns
We will show Retail Methods for the following cost flow assumptions in class
Avg . Cost
Retail cost includes markups, markdowns and abnormal spoilage to determine Cost Retail%
Subtract normal spoilage to determine EIr
LCM ( conventional retail)
Exclude markdowns in determining CostRetail%
Subtract markdowns and normal spoilage to determine EIr
LIFO
Determine CostRetail% for each year and follow Avg cost method

5. Change in Inventory Method
Why Change in Accounting Principle?
Change not involving LIFO
Cumulative Effect of Accounting Change (after tax). Disclosure note and justification needed
Change to LIFO
No cumulative effect (Info unknown). Disclosure note required. LIFO Conformity rule
Change from LIFO
Retroactively restate all previous financial statements. (Comparable basis). Disclosure note required with justification and effect

6. Inventory Errors Inventory Error Discovered in the same year
Correct using AJE
Discovered in the following year
Prior Period Adjustment
Discovered subsequent to the following year
Self corrected, disclosure note if material