9-1 Prepared by Coby Harmon University of California, Santa Barbara Intermediat e Accounting Prepared by Coby Harmon University of California, Santa Barbara Westmont College INTERMEDIATE ACCOUNTING F I F T E E N T H E D I T I O N Prepared by Coby Harmon University of California, Santa Barbara Westmont College kieso weygandt warfield team for success

9-2  Market = Replacement Cost by purchase or production  Value goods at cost or cost to replace, whichever is lower.  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. LO 1 Describe and apply the lower-of-cost-or-market rule. Lower-of-Cost-or-Market

9-3  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 ► Floor Why use Replacement Cost (RC) for Market? LO 1 Describe and apply the lower-of-cost-or-market rule. Ceiling and Floor Lower-of-Cost-or-Market

9-4 Ceiling and Floor A company values inventory at the LCM, with the market limited to an amount that is not more than NRV or less than NRV less a normal profit margin A company values inventory at the LCM, with the market limited to an amount that is not more than NRV or less than NRV less a normal profit margin Ceiling Price: Estimated selling price – estimated disposal cost = Net Realizable Value Ceiling Price: Estimated selling price – estimated disposal cost = Net Realizable Value Floor: Ceiling – Normal Profit Margin Floor: Ceiling – Normal Profit Margin

9-5 Exercise 9-1, 3 SEE EXCEL SEE EXCEL

9-6 Exercise /31/13 Cost of Goods Sold19,000 Inventory19,000 12/31/13 Cost of Goods Sold15,000 Inventory15,000 12/31/14 Loss Due to Market Decline of Inventory19,000 Allowance to Reduce Inventory to Market19,000 12/31/14 Allowance to Reduce Inventory to Market4,000* Loss Due to Market Decline of Inventory4,000

9-7 *Cost of inventory at 12/31/13$346,000 Lower of cost or market at 12/31/13(327,000) Allowance amount needed to reduce inventory to market (a)$ 19,000 Cost of inventory at 12/31/14$410,000 Lower of cost or market at 12/31/14 (395,000) Allowance amount needed to reduce inventory to market (b)$ 15,000 Recovery of previously recognized loss = (a) – (b) $19,000 – $15,000 = $4,000. Both methods of recording lower-of-cost-or-market adjustments have the same effect on net income.

9-8 Used when buying varying units in a single lump-sum purchase. Valuation Bases Valuation Using Relative Sales Value When a group of varying inventory items is purchased for a lump sum price, a problem exists relative to the cost per item. The relative sales value method allocates the total cost to individual items on the basis of the selling price of each item. LO 3 Explain when companies use the relative sales value method to value inventories.

9-9 Exercise 9-8 See Excel See Excel

9-10 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. Gross Profit Method of Estimating Inventory

9-11 Gross Profit Method 1.This method is used when an estimate of a firm’s inventory is required. The resulting estimate is acceptable for interim reporting purposes, but not generally for annual reporting. 2.Four items of information are sufficient to estimate the cost of ending inventory: a.Cost of beginning inventory. b.Cost of purchases for the period. c.Sales during the period. d.Markup, expressed either as a percentage of cost or as a percentage of retail. In the context of the gross profit method, the terms “gross margin,” “gross profit,” and “markup” are synonymous.

9-12 Disadvantages: Gross Profit Method LO 5 Determine ending inventory by applying the gross profit method. (1)Provides an estimate of ending inventory. (2)Uses past percentages in calculation. (3)A blanket gross profit rate may not be representative. (4)Normally unacceptable for financial reporting purposes. GAAP requires a physical inventory as additional verification. Evaluation of Gross Profit Method

9-13 Exercise 12, 13 SEE EXCEL SEE EXCEL

9-14 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. Requires retailers to keep: (1)Total cost and retail value of goods purchased. (2)Total cost and retail value of the goods available for sale. (3)Sales for the period. Methods  Conventional Method  Cost Method  LIFO Retail  Dollar-value LIFO Methods  Conventional Method  Cost Method  LIFO Retail  Dollar-value LIFO

9-15 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 shortages  Abnormal shortages  Employee discounts Special Items Relating to Retail Method When sales are recorded gross, companies do not recognize sales discounts.

9-16 Used for the following reasons: 1)To permit the computation of net income without a physical count of inventory. 2)Control measure in determining inventory shortages. 3)Regulating quantities of merchandise on hand. 4)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. Evaluation of Retail Inventory Method

9-17 Exercise 9-18, 19 SEE EXCEL