Inventories: Additional Issues: © 2013 The Mcgraw-Hill Companies, Inc
Inventories: Additional Issues: © 2013 The Mcgraw-Hill Companies, Inc
Inventories: Additional Issues: © 2013 The Mcgraw-Hill Companies, Inc
INVENTORIES:
ADDITIONAL ISSUES
9-2
Determining Market Value
Designated Cost
Or
Market
(2) less: Estimated
cost of completion
and disposal
Lower of Cost
Or Market
9-4
Lower of Cost or Market
• An item in inventory has a historical cost
of $20 per unit. At year-end we gather the
following per unit information:
• selling price = $30
• cost to complete and dispose = $4
9-5
Lower of Cost or Market
Cost to Net
Selling
- Complete & = Realizable
Price
Dispose Value (NRV)
$ 30.00 - $ 4.00 = $ 26.00
Designated
$21.50
Market?
9-6
Applying Lower of Cost or Market
Lower of cost or market can be applied 2
different ways.
1. Apply
2. Apply1)
LCM Individual
LCMto each Items
to logical
individual
inventory
item in
categories.
2) Group of similarinventory.
or related inventory items
9-7
Adjusting Cost to Market
1. Record the Loss as a Separate Item in
the Income Statement
9-8
Reversal of Write-Downs
9-9
U. S. GAAP vs. IFRS
International standards require inventory to be valued at
the lower of cost or market, but the process is slightly
different for the U.S. method of applying LCM.
9 - 10
U. S. GAAP vs. IFRS
International standards require inventory to be valued at
the lower of cost or market, but the process is slightly
different for the U.S. method of applying LCM.
9 - 11
Inventory Estimation Techniques
Estimate instead of taking physical inventory
1. Less costly
2. Less time consuming
Two popular methods of estimating ending
inventory are the . . .
1. Gross Profit Method
2. Retail Inventory Method
9 - 12
Gross Profit Method
Estimating inventory Auditors are testing the
and COGS for interim overall reasonableness
reports. of client inventories.
Useful
when . . .
9 - 14
Gross Profit Method
Matrix, Inc. uses the gross profit method to estimate
end of month inventory. At the end of May, the
controller has the following data:
9 - 15
Gross Profit Method
Beginning Inventory $ 237,400
Plus: Net Purchases 728,300
= Goods Available for Sale 965,700
Less: Estimated COGS* (691,410)
= Estimated Ending Inventory $ 274,290
9 - 16
The Retail Inventory Method
• This method was developed for retail
operations like department stores.
• Uses both the retail value and cost of
items for sale to calculate a cost to retail
percentage.
9 - 17
The Retail Inventory Method
Retail Terminology
Term Meaning
Initial markup Original amount of markup from cost to selling price.
Additional markup Increase in selling price subsequent to initial markup.
Markup cancellation Elimination of an additional markup.
Markdown Reduction in selling price below the original selling price.
Markdown cancellation Elimination of a markdown.
9 - 18
The Retail Inventory Method
Beginning inventory at
Sales for the period.
retail and cost.
We need to
know . . .
9 - 19
Retail Terminology
9 - 20
The Retail Inventory Method
Matrix, Inc. uses the retail method to estimate
inventory at the end of each month. For the month of
May the controller gathers the following information:
Cost Retail
Inventory, May 1 $ 27,000 $ 45,000
Net purchases for May 180,000 300,000
Goods available for sale 207,000 345,000
Cost-to-Retail Percentage:
(207,000 ÷ 345,000) = 60%
Sales for May (310,000)
Ending inventory at retail $ 35,000
Ending inventory at cost ?
9 - 22
The Retail Inventory Method
Cost Retail
Inventory, May 1 $ 27,000 $ 45,000
Net purchases for May 180,000 300,000
Goods available for sale 207,000 345,000
Cost-to-Retail Percentage:
(207,000 ÷ 345,000) = 60%
Sales for May x (310,000)
Ending inventory at retail × $ 35,000
Ending inventory at cost $ 21,000
9 - 23
Retail Inventory Method
Markups and Markdowns
Matrix, Inc. uses the retail method to estimate
inventory at the end of July. The controller gathers
the following information:
9 - 24
Retail Inventory Method
With Markups and Markdowns
Cost Retail
Inventory, July 1 $ 21,000 $ 35,000
Plus: Net Purchases 200,000 304,000
Net Markups 8,000
Less: Net Markdowns (4,000)
Goods available for sale 221,000 343,000
9 - 25
Retail Inventory Method
With Markups and Markdowns
Cost Retail
Inventory, July 1 $ 21,000 $ 35,000
Plus: Net Purchases 200,000 304,000
Net Markups 8,000
Less: Net Markdowns (4,000)
Goods available for sale 221,000 343,000
Cost ratio:
(221,000 ÷ 343,000) = 64.43% x
Less: Sales for July (300,000)
Ending inventory at retail $ 43,000
Ending inventory at cost $ 27,705
9 - 26
The Retail Inventory Method
We can estimate ending inventory at
average LCM using the cost-to-retail
percentage shown below:
Cost-to- Beginning Inventory + Net Purchases
=
Retail % Retail Value (Beginning Inventory + Net
Purchases + Net Markups)
9 - 27
Other Issues of Retail Method
Element Treatment
Before calculating the cost-to-retail percentage
Freight-in Added to the cost column
Purchase returns Deducted in both the cost and retail columns
Purchase discounts taken Deducted in the cost column
Abnormal shortage, spoilage, or theft Deducted in both the cost and retail columns
After calculating the cost-to-retain percentage
Normal shortage, spoilage, or theft Deducted in the retail column
Employee discounts Added to net sales
9 - 28
Changes in Inventory Method
Recall that most voluntary changes in
accounting principles are reported
retrospectively. This means reporting all
previous periods’ financial statements as
though the new method had been used in
all prior periods.
Changes in inventory methods, Except when it is
impracticable to determine either the period-
specific effects or the cumulative effects of the
changes, are treated retrospectively.
9 - 29
Change To The LIFO Method
When a company elects to change to LIFO, it is
usually impossible to calculate the income effect
on prior years. As a result, the company does not
report the change retrospectively. Instead, the LIFO
method is used from the point of adoption forward.
9 - 30
Analyzing Inventory Errors
9 - 31
Inventory Errors
9 - 32
Inventory Errors
9 - 33
Inventory Errors
When the Inventory Error is Discovered the Following Year
If an error was made in 2012, but not discovered until 2013, the 2012
financial statements were incorrect as a result of the error. The error
should be retrospectively restated to reflect the correct inventory amount,
cost of goods sold, net income, and retained earnings when the
comparative 2012 and 2013 financial statements are issued in 2013.
9 - 34
Inventory Errors
Overstatement of purchases
◦ Overstates cost of goods sold and
◦ Understates pretax income.
Understatement of purchases
◦ Understates cost of goods sold and
◦ Overstates pretax income.
9 - 35
Earnings Quality
Many believe that manipulating income reduces
earnings quality because it can mask permanent
earnings. Inventory write-downs and changes in
inventory method are two additional inventory-
related techniques a company could use to
manipulate earnings.
9 - 36
End of Chapter 9
9 - 37