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Inventories: Additional Valuation Issues
Inventories: Additional Valuation Issues
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Learning
Learning Objectives
Objectives
1. Describe and apply the lower-of-cost-or-net realizable value rule.
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Inventories:
Inventories:Additional
Additional Valuation
Valuation Issues
Issues
Lower-of-Cost-
or-Net Gross Profit Retail Inventory Presentation and
Valuation Bases
Realizable Method Method Analysis
Value (LCNRV)
LCNRV
A company abandons the historical cost principle
when the future utility (revenue-producing ability)
of the asset drops below its original cost.
12,000
COGS
COGS Cost of goods sold 12,000
Method
Method Inventory
9-10 LO 1 12,000
Describe and apply the lower-of-cost-or-net realizable value rule.
Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
9-12 LO 1
Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Use of an Allowance
Instead of crediting the Inventory account for net realizable
value adjustments, companies generally use an
allowance account.
12,000
33,800
Reported in statement of financial position reports the
Biological Asset—Milking Cows as a non-current asset at fair
value less costs to sell (net realizable value).
Cash 38,500
Sales 38,500
or
(3) too difficult to obtain cost figures (meatpacking).
x = x =
x =
(3) The sales, reduced to cost, deducted from the sum of the
opening inventory plus purchases, equal ending
inventory.
Illustration 9-13
Instructions:
(a) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of sales.
(b) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of cost.
9-37 LO 5
Gross
Gross Profit
Profit Method
Method
(Solution):
(a) Compute the estimated inventory assuming gross profit is 25% of sales.
25%
= 20% of sales
100% + 25%
Evaluation
Disadvantages:
(1) Provides an estimate of ending inventory.
Instructions:
Prepare a schedule
computing estimate
retail inventory using
the following
methods:
(1) Conventional
(2) Cost
/ =
/ =
Special Items
Freight costs
Purchase returns
Purchase discounts and allowances
Transfers-in
Normal spoilage
Abnormal shortages
Employee discounts
Special
Items
Illustration 9-22
Evaluation
Widely used for the following reasons:
(1) To permit the computation of net income without a
physical count of inventory.
(2) Control measure in determining inventory shortages.
(3) Regulating quantities of merchandise on hand.
(4) Insurance information.
Presentation of Inventories
Accounting standards require disclosure of:
(1) Accounting policies adopted in measuring inventories,
including the cost formula used (weighted-average, FIFO).
(2) Total carrying amount of inventories and the carrying amount
in classifications (merchandise, production supplies, raw
materials, work in progress, and finished goods).
(3) Carrying amount of inventories carried at fair value less costs
to sell.
(4) Amount of inventories recognized as an expense during the
period.
Presentation of Inventories
Accounting standards require disclosure of:
(5) Amount of any write-down of inventories recognized as an
expense in the period and the amount of any reversal of
write-downs recognized as a reduction of expense in the
period.
(6) Circumstances or events that led to the reversal of a write-
down of inventories.
(7) Carrying amount of inventories pledged as security for
liabilities, if any.
Analysis of Inventories
Common ratios used in the management and evaluation of
inventory levels are inventory turnover and average days to
sell the inventory.
Illustration: In its 2009 annual report Tate & Lyle plc (GBR)
reported a beginning inventory of £562 million, an ending inventory
of £538 million, and cost of goods sold of £2,019 million for the
year.
Illustration 9-25
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In the lower-of-cost-or-market test for inventory valuation, IFRS defines
market as net realizable value. U.S. GAAP, on the other hand, defines
market as replacement cost subject to the constraints of net realizable
value (the ceiling) and net realizable value less a normal markup (the
floor). IFRS does not use a ceiling or a floor to determine market.
Under U.S. GAAP, if inventory is written down under the LCM valuation,
the new basis is now considered its cost. As a result, the inventory may
not be written back up to its original cost in a subsequent period. Under
IFRS, the write-down may be reversed in a subsequent period up to the
amount of the previous write-down. Both the write-down and any
subsequent reversal should be reported on the income statement.
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Unlike property, plant, and equipment, IFRS does not permit the option
of valuing inventories at fair value. As indicated above, IFRS requires
inventory to be written down, but inventory cannot be written up above
its original cost.
As indicated, IFRS requires both biological assets and agricultural
produce at the point of harvest to be reported to net realizable value.
U.S. GAAP does not require companies to account for all biological
assets in the same way. Furthermore, these assets generally are not
reported at net realizable value. Disclosure requirements also differ
between the two sets of standards.
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Copyright
Copyright
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programs or from the use of the information contained herein.
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