1. Chapter 9 - Inventories: Additional Valuation Issues
ACTG 3110
Chapter 9 - Inventories: Additional Valuation Issues

2. Lower of Cost or Market Valuation
Generally replacement cost
Should not exceed the net realizable value or “ceiling”
Should not be lower than the net realizable value less a normal markup or “floor”
Market is the middle of the three values above

3. Lower of Cost or Market Valuation
Application
By item (most conservative)
By classification
To total inventory
When item is written down, the “market value” becomes its cost for future periods

4. Methods of Recording LCM Adjustments
Direct inventory reduction
Reduce inventory account
No holding loss separately stated
Holding loss recorded in cost of goods sold
Allowance Method
“Allowance to reduce inventory to market” is a contra-inventory account
Inventory stated at initial cost
Holding loss is recorded on income statement
Holding gains allowed up to previous balance

5. Valuation Bases Valuation at Net Realizable Value
Selling costs less estimated costs to complete and sell
Must meet two conditions including having a controlled market
Valuation using Relative Sales Value
Used to separate costs within a basket purchase
Purchase Commitments
Not on balance sheet or income statement normally
Must be disclosed if material
If contract price will result in a loss, the loss must be recorded when the market price decline occurs

6. Gross Margin Method Used to estimate inventory
Assumes gross margin is constant in the short run
Not GAAP for annual reports, but can be used for interim reporting
Steps
Estimate the gross margin rate
Compute cost of goods available for sale
Determine gross margin from gross margin rate X sales

7. Gross Margin Method Steps (continued)
Compute cost of goods sold by subtracting gross margin from sales
Compute ending inventory by subtracting cost of goods sold from costs available for sale
Limitations - only as good as the estimates
Applications - casualty losses such as tornadoes, fires, floods, etc.

8. Retail Inventory Method
Acceptable for financial reporting
Used by merchandisers
Inventory is assigned both a cost and a retail price
Inventory is taken by retail cost
“Cost” of ending inventory is backed into

9. Retail Inventory Method
Definitions
Markups
Additional markups
Markup cancellations
Markdowns
Markdown cancellations
Inventory is kept in dollars, not units

10. Retail Inventory Method
Cost ratio determination:
Average cost = beginning inventory + purchases
Conventional or Average Cost LCM - does not include markdowns
Reflects the most conservative percentage because markdowns are written off
Freight in only included in cost column
Purchases discounts only affect cost column
Purchases returns affect both cost and retail

11. Retail Inventory Method
Abnormal shortages should be deducted from both the cost and retail columns and reported as a special inventory amount or as a loss
Normal shortages only affect the retail inventory
Sales returns and allowances are proper adjustments to sales
Employee discounts are deducted from sales but not included in the cost-to-retail percentage

12. Presentation and Analysis
Inventory is presented in the balance sheet- generally in current assets
A company can use different costing methods for different elements of inventory
Analysis of inventory – inventory turnover
Cost of goods sold/inventory
Tells us how many times the inventory was sold during the year
Can convert to average days to sell by dividing the inventory turnover into 365 days