Inventories:

Inventories: Additional
Additional
Valuation
Valuation Issues
Issues

Chapter
9

Chapter
9-1
 Lower-of-Cost-or-Market
Lower-of-Cost-or-Market

LCM
A company abandons the historical cost principle when
the future utility (revenue-producing ability) of the
asset drops below its original cost.
Lower of Cost or Market value determined
Market = Replacement Cost if reasonable or other
calculated amounts if not reasonable
Loss should be recorded when loss occurs, not in the
period of sale.

Chapter
9-2
 Lower-of-Cost-or-Market
Lower-of-Cost-or-Market

Ceiling and Floor

Why FASB start with Replacement Cost (RC) for
Market?
RC allows a consistent rate of gross profit.
Decline in the RC usually = decline in selling price.
If reduction in RC fails to indicate reduction in utility,
then two additional valuation limitations are used:
 Ceiling - net realizable value (selling price minus
selling/disposal costs)
 Floor - net realizable value less a normal profit margin.

Chapter
9-3
 Lower-of-Cost-or-Market
Lower-of-Cost-or-Market
E9-2

Chapter
9-4
 Lower-of-Cost-or-Market
Lower-of-Cost-or-Market
Recording LCM
Ending inventory (cost) $ 415,000
Ending inventory (LCM) 350,000
Adjustment to LCM $ 65,000

Allowance
Allowance Loss on inventory 65,000
Method
Method Allowance on inventory 65,000

Direct
Direct Cost of goods sold 65,000
Method
Method Inventory 65,000

Chapter
9-5
 Lower-of-Cost-or-Market
Lower-of-Cost-or-Market

Balance Sheet Presentation

Allowance Direct
Current assets:
Cash $ 100,000 $ 100,000
Accounts receivable 350,000 350,000
Inventory 770,000 705,000
Less: inventory allowance (65,000)
Prepaids 20,000 20,000
Total current assets 1,175,000 1,175,000

Chapter
9-6
 Lower-of-Cost-or-Market
Lower-of-Cost-or-Market
Income Statement Presentation Allowance Direct
Sales $ 300,000 $ 300,000
Cost of goods sold 120,000 185,000
Gross profit 180,000 115,000
Operating expenses:
Selling 45,000 45,000
General and administrative 20,000 20,000
Total operating expenses 65,000 65,000
Other revenue and expense:
Loss on inventory 65,000 -
Interest income 5,000 5,000
Total other (60,000) 5,000
Income from operations 55,000 55,000
Income tax expense 16,500 16,500
Net income $ 38,500 $ 38,500
Chapter
9-7
 Lower-of-Cost-or-Market
Lower-of-Cost-or-Market

E9-4, P9-3

Chapter
9-8
 Inventory
Inventory Estimation
Estimation Techniques
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

Chapter
9-9
 Inventory
Inventory Estimation
Estimation Techniques
Techniques -- Retail
Retail
Inventory
Inventory Method
Method

A method used primarily by retailers

Accepted by IRS and FASB for reporting
inventory
Requires retailers to keep:

(1) the total cost and retail value of goods purchased,

(2) the total cost and retail value of the goods available
for sale, and
(3) the sales for the period.

Chapter
9-10
 Retail
Retail Inventory
Inventory Method
Method

Step 1: Calculate Ending inventory info at

retail:
BI® + Purch® – Sales = EI®
Note: CGAS® = BI® + Purch®

Step 2: Calculate a Cost to retail %:

CGAS © / CGAS ®

Step 3: Estimate EI ©:
EI © = EI ® * CGAS © / CGAS ®
Chapter
9-11
 Retail
Retail Inventory
Inventory Method
Method
Main differences in 3 Retail Inventory Methods:
1) Average Cost
Retail cost includes markups, markdowns to
determine Cost-to-Retail%
2) LCM ( conventional retail)
Exclude markdowns in determining Cost-to-
Retail%
3) LIFO
Determine Cost-to-Retail% for beginning and
current period inventory layers (based on Avg.
Chapter
9-12
cost method)
 Retail
Retail Inventory
Inventory Method
Method
Include Additional items that affect CostRetail%
and EI at retail prices (discussed in handout).

Chapter
9-13
 Retail
Retail Inventory
Inventory Method
Method
E 9-19 (adapted)

Chapter
9-14
 Purchase
Purchase Commitments
Commitments

Generally seller retains title to the merchandise.

Buyer recognizes no asset or liability.
If material, the buyer should disclose contract details in
footnote.
If the contract price is greater than the market price,
and the buyer expects that losses will occur when the
purchase is effected, the buyer should recognize holding
losses in the period during which such declines in market
prices take place.
No holding gains are recognized.

Chapter
9-15
 Purchase
Purchase Commitments
Commitments

See BE 9-5 & 6

Chapter
9-16
 Inventory
Inventory Estimation
Estimation Techniques
Techniques -- Gross
Gross
Profit
Profit Method
Method
Provides an estimate of ending inventory.
Only acceptable for interim (generally quarterly)
reporting purposes.
Relies on Three Assumptions:
(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.
Chapter
9-17
 Gross
Gross Profit
Profit Method
Method

Computation of Gross Profit Percentage

Illustration 9-17

Chapter
9-18
 Gross
Gross Profit
Profit Method
Method
BE 9-7, E9-12

Chapter
9-19
  U.S. GAAP permits the use of LIFO for inventory valuation. iGAAP
prohibits its use.
 In the lower-of-cost-or-market test for inventory valuation, iGAAP
defines market as net realizable value. U.S. GAAP defines market
as replacement cost subject to the constraints.
 In U.S. GAAP, inventory written down under the lower-of-cost-or-
market valuation may not be written back up to its original cost in a
subsequent period. Under iGAAP, the write-down may be reversed
in a subsequent period.
Chapter
9-20