Chapter 9 Inventories: Additional Valuation Problems

Lower of Cost or Market (LCM) v Goal: to be conservative but objective (without income manipulation chances) v Market (Designated Market Value): is defined as the replacement cost bounded by a ceiling(NRV) & a floor (NRV- normal profit margin) v NRV = estimated selling price - additional cost - estimated disposal cost

Procedures of Applying LCM v Find the designated “market value” by picking the middle value of replacement cost, the ceiling, and floor v Find the lower of historical cost or “designated market value” v Apply LCM (a) to each item or (b) to each major category or (c) to the total of the inventory

Examples of Applying LCM Historical Replace- NRV NRV Less Historical Replace- NRV NRV Less Case Cost ment Cost Normal Profit A $30 $35 $40 $20 A $30 $35 $40 $20 B B C C LCM Solution: A = $30; B= $23; C = $14 A = $30; B= $23; C = $14

Recording Market Decline in Inventory--Perpetual Inventory v Direct Method: Cost of Goods Sold XXX Inventory XXX Inventory XXX v Indirect Method: Loss Due to Market Decline XXX Allowance XXX Allowance XXX Or if “market” recovers Allowance XXX Recovery of Loss XXX Recovery of Loss XXX

Other Valuation Bases v Inventory sold in controlled market with quoted price is valued at NRV v Joint cost in a lump-sum purchase is allocated based on relative sales value v Standard cost (non-GAAP) v Gross profit method (non-GAAP) v The retail inventory method (GAAP)

Gross Profit Method v EI=BI + Purchase - COGS v COGS= Sales - Gross Profit (GP) v Gross Profit= Sales x GP/Sales v GP/Sales= Gross Margin on Sales v Conversion of Markup On Cost to Gross Margin on Sales: GP/Sales=(GP/COGS)/[100%+(GP/COGS)] GP/Sales=(GP/COGS)/[100%+(GP/COGS)] e.g., GP/COGS= 25% GP/Sales= 20% e.g., GP/COGS= 25% GP/Sales= 20%

Retail Inventory Method v Conventional Retail method: –Weighted Average flow assumption –Mark-down is treated as additional COGS to approximate LCM valuation v Retail LIFO (stable prices) –LIFO flow assumption –Markdown receives no special treatment v Dollar-value LIFO retail (unstable price)

Conventional Retail Method-- Estimating Cost to Retail Ratio Cost Retail Cost Retail Beginning Inventory $3,000 $5,000 Purchases 20,000 40,000 Purchase discounts (1,000) Freight-in 2,000 Net Markups 2,000 Abnormal Shortage (3,000) (7,000) Goods Available for Sale $21,000 $40,000 Goods Available for Sale $21,000 $40,000 Cost to Retail ratio: $21,000/$40,000 = 52.5% Cost to Retail ratio: $21,000/$40,000 = 52.5%

Conventional Retail Method- Estimating Cost of Inventory Cost Retail Cost Retail Goods available for sale $21,000 $40,000 Gross sales (25,000) Less: sales returns 2,000 Net markdowns (3,000) Employee discount granted (1,500) Normal shortage (500) Ending Inventory ??? $12,000 Ending Inventory ??? $12,000 Cost of Ending Inventory=$12,000x.525 =$6,300

Retail LIFO (Stable Prices)-- Estimating Cost to Retail Ratio Cost Retail Cost Retail Beginning Inventory $3,000 $5,000 Net Purchases 21,000 40,000 Net Markups 2,000 Net Markdowns (3,000) Abnormal Shortage (3,000) (7,000) Goods Available for Sale $21,000 $37,000 Goods Available for Sale $21,000 $37,000 Previous Cost/Retail ratio: $3,000/$5,000 =60% Current Cost/Retail ratio:18,000/32,000=56.25%

Retail LIFO (Stable Prices)-- Estimating Cost of Inventory Cost Retail Cost Retail Goods available for sale $21,000 $37,000 Gross sales (25,000) Less: sales returns 2,000 Employee discount granted (1,500) Normal shortage (500) Ending Inventory ??? $12,000 Ending Inventory ??? $12,000 EI=$5,000x.6000 =$3, EI=$5,000x.6000 =$3, $7,000x.5625=$3, $6, $7,000x.5625=$3, $6,937.50

Dollar Value LIFO Retail-- Estimating Cost to Retail Ratio Cost Retail PI Cost Retail PI Beginning Inventory $3,000 $5, Net Purchases 21,000 40, Net Markups 2, Net Markdowns (3,000) 1.2 Abnormal Shortage (3,000) (7,000 ) 1.2 Goods Available $21,000 $37,000 Goods Available $21,000 $37,000 Previous Cost/Retail ratio: $3,000/$5,000 =60% Current Cost/Retail ratio:18,000/32,000=56.25%

Dollar Value LIFO Retail-- Estimating Cost of Inventory Cost Retail PI EI(base) Cost Retail PI EI(base) Goods available $21,000 $37,000 Net sales etc... (25,000) Ending Inventory ??? $12,000/1.2= $10,000 Cost of E/I: $5,000x1.0x.6000 = $3,000 $5,000x1.2x.5625 = $3,375 $6,375 $6,375