1. HIGHLIGHTS OF CHAPTER 9: Additional Issues March 2004 March 2004

2. SIGNIFICANT ISSUES  Lower of cost or market  Gross profit method  Retail method  Dollar-value retail method  Change in inventory method  Correction of error  Purchase commitments

3. LOWER OF COST OR MARKET  Principle of conservatism  Replacement cost v NRV  Applying floor & ceiling  Designated market value v Cost  3 application approaches

4. FLOOR & CEILING  Ceiling - Net Realizable Value  Replacement cost  Floor - NRV less normal profit

5. APPLYING RULE Ceiling: Sales price 1,200 Cost to complete 100 NRV 1,100 NRV 1,100Floor: NRV 1,100 Normal profit 120 NRV less profit 980 NRV less profit 980

6. APPLYING RULE Cost 1,000 Ceiling - NRV 1,100 Replacement cost 950 Floor - NRV less profit 980 Designated market value 980 ALWAYS CHOOSE THE VALUE IN THE MIDDLE ALWAYS CHOOSE THE VALUE IN THE MIDDLE

7. THREE APPROACHES  Item by item  By group  Entire inventory

8. GROSS PROFIT METHOD  Estimate ending inventory  Based on normal gross profits  Only an estimate!

9. GROSS PROFIT METHOD Beginning inventory (at cost) $60,000 Purchases (at cost)200,000 Total goods available for sale 260,000 Total goods available for sale 260,000 Sales (at selling price) $280,000 Less: Gross profit at 30% 84,000 Sales (at cost) 196,000 Sales (at cost) 196,000 Estimated inventory (at cost) $64,000 Estimated inventory (at cost) $64,000

10. GROSS PROFIT RATIO  % of sales  Alternative is markup on cost -Stated as % of cost Cost $100 Gross profit 50 Gross profit 50 Markup on cost 50%

11. RETAIL METHOD COST RETAIL Beginning inventory $1,000$1,800 Purchases 30,00060,000 Freight-in 600 - Purchase returns (1,500) (3,000) Net mark-ups 9,000 Abnormal shortages (1,200) (2,000) Total $28,900 $65,800 Total $28,900 $65,800 Cost-to-retail % = 28900/65800 = 43.9%

12. RETAIL METHOD RETAIL RETAIL Total available for sale at retail $65,800 Less: Net markdowns 1,400 Sales $36,000 Sales $36,000 Sales returns (900) 35,100 Employee discounts 800 Normal shortages 1,300 Ending inventory at retail $27,200 Ending inventory at retail $27,200 Cost-to-retail % 43.9% Cost-to-retail % 43.9% Ending inventory at cost $11,941 Ending inventory at cost $11,941

13. LIFO RETAIL METHOD COST RETAIL Beginning inventory 2001 $27,000$45,000 Purchases, net 346,500480,000 Net mark-ups 20,000 Net mark-downs _______ ( 5,000) Total $346,500 $495,000 Total $346,500 $495,000 Net sales 484,000 Ending inventory 2001 at retail $ 56,000 2001 Cost-to-retail % (346,500/495,000) 70.0% 2001 Cost-to-retail % (346,500/495,000) 70.0%

14. LIFO RETAIL METHOD Ending inventory 2001 at retail $ 56,000 Cost-to- LIFO Cost-to- LIFO Layer Retailretail % Cost__ 2000 $45,000 60%$27,000 2001 11,000 70%_ 7,700 $56,000 $34,700 $56,000 $34,700

15. DOLLAR-VALUE LIFO COST RETAIL Beginning inventory 2001 $27,000$45,000 Purchases, net 346,500480,000 Net mark-ups 20,000 Net mark-downs _______ ( 5,000) Total $346,500 $495,000 Total $346,500 $495,000 Net sales 484,000 Ending inventory 2001 at retail $ 56,000 2001 Cost-to-retail % (346,500/495,000) 70.0% 2001 Cost-to-retail % (346,500/495,000) 70.0%

16. DOLLAR-VALUE LIFO Ending inventory 2001 at retail $ 56,000 Price indexes: 2000100% 2001112% Ending inventory 2001 at retail deflated to base- year prices (56,000 /112%) $ 50,000

17. DOLLAR-VALUE LIFO Ending inventory 2001 at retail $ 56,000 Ending inventory 2001 at base-year $ 50,000 Beginning inventory 2001 at base-year 45,000 Inventory increase at base-year prices 5,000 Price Cost-to- LIFO Price Cost-to- LIFO Layer Retail Indexretail % Cost__ 2000 $45,000 100% 60%$27,000 2001 5,000 112% 70%_ 3,920 $50,000 $30,920 $50,000 $30,920

18. DOLLAR-VALUE LIFO Ending inventory 2002 at retail $ 64,800 Ending inventory 2002 at base-year $ 54,000 Beginning inventory 2002 at base-year 50,000 Inventory increase at base-year prices 4,000 Price Cost-to- LIFO Price Cost-to- LIFO Layer Retail Indexretail % Cost__ 2000 $45,000 100% 60%$27,000 2001 5,000 112% 70% 3,920 2002 4,000 120% 75%_ 3,600 $54,000 $34,520 $54,000 $34,520

19. CHANGE IN METHOD  Cumulative effect on prior years included in current P/L  Change to LIFO reported on prospective basis  Change from LIFO reported on retroactive basis by restating prior year statements

20. CORRECTION OF ERROR  Restating prior year statements  Record adjustments

21. EFFECT OF INVENTORY ERRORS  Beginning inventory  Ending inventory  Purchases  Cost of goods sold  Retained earnings  Following years

22. PURCHASE COMMITMENTS  Record loss when price declines – not when sold  Record purchase at market value  Loss on future purchases creates a future estimated liability