kieso

weygandt
warfield
INTERMEDIATE team for success

Intermediat
F I F T E E N T H E D I T I O N

Intermediat
ACCOUNTING
e e
Accounting
Accounting

Prepared by
Coby Harmon
Prepared by
University of California,
CobySanta Barbara
Harmon Prepared by
Westmont
University College SantaCoby
of California,
Harmon
Barbara
University of California, Santa Barbara
9-1 Westmont College
 PREVIEW OF CHAPTER 9

Intermediate Accounting
15th Edition
Kieso Weygandt Warfield
9-2
 9 Inventories: Additional
Valuation Issues
LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:

1. Describe and apply the lower-of-cost-or- 5. Determine ending inventory by applying

market rule. the gross profit method.
2. Explain when companies value 6. Determine ending inventory by applying
inventories at net realizable value. the retail inventory method.
3. Explain when companies use the relative 7. Explain how to report and analyze
sales value method to value inventories. inventory.
4. Discuss accounting issues related to
purchase commitments.

9-3
 Lower-of-Cost-or-Market

A company abandons the historical cost principle when the

future utility (revenue-producing ability) of the asset drops
below its original cost.
 Market = Replacement Cost.
 Value goods at cost or cost to replace, whichever is
lower.
 Loss should be recorded when
loss occurs, not in the period of sale.

9-4 LO 1 Describe and apply the lower-of-cost-or-market rule.

 Lower-of-Cost-or-Market
Illustration 9-1
Lower-of-Cost-or-
Market Disclosures

9-5 LO 1
 Lower-of-Cost-or-Market

Ceiling and Floor

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

9-6 LO 1 Describe and apply the lower-of-cost-or-market rule.

 Lower-of-Cost-or-Market

Net realizable value (NRV) is the is the estimated selling

price in the ordinary course of business, less reasonably
predictable costs of completion and disposal (often referred
to as net selling price).
Illustration 9-2

9-7 LO 1 Describe and apply the lower-of-cost-or-market rule.

 Lower-of-Cost-or-Market
Illustration 9-3

What is the rationale for the

Ceiling = NRV
Ceiling and Floor limitations?
Not
>

Replacement
Cost Market Cost
Cost Market
Not
<

Floor =
GAAP
GAAP NRV less Normal
LCM
LCM Profit Margin

9-8 LO 1 Describe and apply the lower-of-cost-or-market rule.

 Lower-of-Cost-or-Market

What is the rationale for the Ceiling and Floor limitations?

 Ceiling – prevents overstatement of the value of obsolete,
damaged, or shopworn inventories.
 Floor – deters understatement of inventory and
overstatement of the loss in the current period.

9-9 LO 1 Describe and apply the lower-of-cost-or-market rule.

 Lower-of-Cost-or-Market

How Lower-of-Cost-or-Market Works

Illustration 9-5

Advance slide in
presentation mode to
9-10 reveal answers. LO 1 Describe and apply the lower-of-cost-or-market rule.
 Lower-of-Cost-or-Market

Methods of Applying Lower-of-Cost-or-Market

Illustration 9-6

Advance slide in
presentation mode to
9-11 reveal answers. LO 1 Describe and apply the lower-of-cost-or-market rule.
 Lower-of-Cost-or-Market

Recording “Market” Instead of Cost

Ending inventory (cost) $ 82,000
Ending inventory (market) 70,000
Adjustment to LCM $ 12,000

Loss
Loss Loss Due to Decline in Inventory 12,000
Method
Method Allowance to Reduce Inventory to Market

12,000
COGS
COGS Cost of Goods Sold 12,000
Method
Method Inventory

9-12
12,000 LO 1 Describe and apply the lower-of-cost-or-market rule.
 Lower-of-Cost-or-Market

Balance Sheet
Loss COGS
Method Method
Current assets:
Cash $ 100,000 $ 100,000
Accounts receivable 350,000 350,000
Inventory 770,000 (758,000)
Less: allowance to market (12,000)
Prepaids 20,000 20,000
Total current assets 1,175,000 1,175,000

9-13 LO 1 Describe and apply the lower-of-cost-or-market rule.

 Lower-of-Cost-or-Market
Loss COGS
Income Statement
Method Method
Sales $ 300,000 $ 300,000
Cost of goods sold 120,000 132,000
Gross profit 180,000 168,000
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 (12,000) -
Interest income 5,000 5,000
Total other (7,000) 5,000
Income from operations 108,000 108,000
Income tax expense 32,400 32,400
Net income $ 75,600 $ 75,600
9-14 LO 1
 Lower-of-Cost-or-Market
Illustration: Remmers Company manufactures desks. The company
attempts to obtain a 20% gross margin on selling price. At December 31,
2014, the following finished desks appear in the company’s inventory.

The 2014 catalog was in effect through November 2014, and the 2015
catalog is effective as of December 1, 2015.
Instructions: At what amount should each of the four desks appear in the
company’s December 31, 2015, inventory, assuming that the company has
adopted a lower-of-FIFO-cost-or-market approach for valuation of
inventories on an individual-item basis?
9-15 LO 1
 Lower-of-Cost-or-Market

Finished Desks A
Ceiling = 450
Inventory cost $ 470
(500 – 50)
Est. cost to manufacture 460
Commissions and disposal costs 50 Not
Catalog selling price 500 >

Replacement
Cost = 460
Cost
Cost == 470
470 Market
Market == 450
450 Not
<

Floor = 350
(450-(500 x 20%))
LCM
LCM == 450
450

9-16 LO 1
 Lower-of-Cost-or-Market

Finished Desks B
Ceiling = 480
Inventory cost $ 450
(540 – 60)
Est. cost to manufacture 430
Commissions and disposal costs 60 Not
Catalog selling price 540 >

Replacement
Cost = 430
Cost
Cost == 450
450 Market
Market == 430
430 Not
<

Floor = 372
(480-(540 x 20%))
LCM
LCM == 430
430

9-17 LO 1
 Lower-of-Cost-or-Market

Finished Desks C
Ceiling = 820
Inventory cost $ 830
(900 – 80)
Est. cost to manufacture 610
Commissions and disposal costs 80 Not
Catalog selling price 900 >

Replacement
Cost = 610
Cost
Cost == 830
830 Market
Market == 640
640 Not
<

Floor = 640
(820-(900 x 20%))
LCM
LCM == 640
640

9-18 LO 1
 Lower-of-Cost-or-Market

Finished Desks D
Ceiling = 1,070
Inventory cost $ 960
(1,200 – 130)
Est. cost to manufacture 1,000
Commissions and disposal costs 130 Not
Catalog selling price 1,200 >

Replacement
Cost = 1,000
Cost
Cost == 960
960 Market
Market == 1,000
1,000 Not
<

Floor = 830
(1,070-(1,200 x 20%))
LCM
LCM == 960
960

9-19 LO 1
 Lower-of-Cost-or-Market

Use of an Allowance—Multiple Periods

In general, accountants leave the allowance account on the
books. They merely adjust the balance at the next year-end to
agree with the discrepancy between cost and the lower-of-cost-
or-market at that balance sheet date.
Illustration 9-10

9-20 LO 1 Describe and apply the lower-of-cost-or-market rule.

 Lower-of-Cost-or-Market

Evaluation of Lower-of-Cost-or-Market Rule

Some Deficiencies:
 Expense recorded when loss in utility occurs. Profit on sale
recognized at the point of sale.
 Inventory valued at cost in one year and at market in the next
year.
 Net income in year of loss is lower. Net income in subsequent
period may be higher than normal if expected reductions in
sales price do not materialize.
 LCM uses a “normal profit” in determining inventory values,
which is a subjective measure.

9-21 LO 1 Describe and apply the lower-of-cost-or-market rule.

 9 Inventories: Additional
Valuation Issues
LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:

1. Describe and apply the lower-of-cost-or- 5. Determine ending inventory by applying

market rule. the gross profit method.
2. Explain when companies value 6. Determine ending inventory by applying
inventories at net realizable value. the retail inventory method.
3. Explain when companies use the relative 7. Explain how to report and analyze
sales value method to value inventories. inventory.
4. Discuss accounting issues related to
purchase commitments.

9-22
 Valuation Bases

Valuation at Net Realizable Value

Permitted by GAAP under the following conditions:

(1) a controlled market with a quoted price applicable to all

quantities, and

(2) no significant costs of disposal

or

(3) too difficult to obtain cost figures.

9-23 LO 2 Explain when companies value inventories at net realizable value.

 9 Inventories: Additional
Valuation Issues
LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:

1. Describe and apply the lower-of-cost-or- 5. Determine ending inventory by applying

market rule. the gross profit method.
2. Explain when companies value 6. Determine ending inventory by applying
inventories at net realizable value. the retail inventory method.
3. Explain when companies use the relative 7. Explain how to report and analyze
sales value method to value inventories. inventory.
4. Discuss accounting issues related to
purchase commitments.

9-24
 Valuation Bases

Valuation Using Relative Sales Value

Used when buying varying units in a single lump-sum purchase.

Illustration: Woodland Developers purchases land for $1 million

that it will subdivide into 400 lots. These lots are of different sizes
and shapes but can be roughly sorted into three groups graded A,
B, and C. As Woodland sells the lots, it apportions the purchase
cost of $1 million among the lots sold and the lots remaining on
hand. Calculate the cost of lots sold and gross profit.

LO 3 Explain when companies use the relative

9-25
sales value method to value inventories.
 Valuation Bases Illustration 9-11
Allocation of Costs,
Using Relative Sales Value

Illustration 9-12
Determination of Gross Profit,
Using Relative Sales Value

LO 3 Explain when companies use the relative

9-26
sales value method to value inventories.
 9 Inventories: Additional
Valuation Issues
LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:

1. Describe and apply the lower-of-cost-or- 5. Determine ending inventory by applying

market rule. the gross profit method.
2. Explain when companies value 6. Determine ending inventory by applying
inventories at net realizable value. the retail inventory method.
3. Explain when companies use the relative 7. Explain how to report and analyze
sales value method to value inventories. inventory.
4. Discuss accounting issues related to
purchase commitments.

9-27
 Valuation Bases

Purchase Commitments—A Special Problem

► Generally seller retains title to the merchandise.

► Buyer recognizes no asset or liability.

► If material, the buyer should disclose contract details in

note in the financial statements.
► 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 losses
in the period during which such declines in market prices
take place.

9-28 LO 4 Discuss accounting issues related to purchase commitments.

 Valuation Bases

Illustration: St. Regis Paper Co. signed timber-cutting contracts

to be executed in 2015 at a price of $10,000,000. Assume
further that the market price of the timber cutting rights on
December 31, 2014, dropped to $7,000,000. St. Regis would
make the following entry on December 31, 2014.

Unrealized Holding Gain or Loss—Income 3,000,000

Estimated Liability on Purchase Commitment

Other expenses and losses in the Income statement.

3,000,000

Current liabilities on the balance sheet.

9-29 LO 4 Discuss accounting issues related to purchase commitments.

 Valuation Bases

Illustration: When St. Regis cuts the timber at a cost of $10

million, it would make the following entry.

Purchases (Inventory) 7,000,000

Est. Liability on Purchase Commitment 3,000,000
Cash
10,000,000
Assume the Congress permitted St. Regis to reduce its contract
price and therefore its commitment by $1,000,000.

Est. Liability on Purchase Commitment 1,000,000

Unrealized Holding Gain or Loss—Income 1,000,000

9-30 LO 4 Discuss accounting issues related to purchase commitments.

 9 Inventories: Additional
Valuation Issues
LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:

1. Describe and apply the lower-of-cost-or- 5. Determine ending inventory by applying

market rule. the gross profit method.
2. Explain when companies value 6. Determine ending inventory by applying
inventories at net realizable value. the retail inventory method.
3. Explain when companies use the relative 7. Explain how to report and analyze
sales value method to value inventories. inventory.
4. Discuss accounting issues related to
purchase commitments.

9-31
 Gross Profit Method of Estimating Inventory

Substitute Measure to Approximate Inventory

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.

9-32 LO 5 Determine ending inventory by applying the gross profit method.

 Gross Profit Method

Illustration: Cetus Corp. has a beginning inventory of $60,000

and purchases of $200,000, both at cost. Sales at selling price
amount to $280,000. The gross profit on selling price is 30
percent. Cetus applies the gross margin method as follows.
Illustration 9-14

9-33 LO 5 Determine ending inventory by applying the gross profit method.

 Gross Profit Method

Computation of Gross Profit Percentage

Illustration: In Illustration 9-14, the gross profit was a given. But
how did Cetus derive that figure? To see how to compute a gross
profit percentage, assume that an article cost $15 and sells for
$20, a gross profit of $5.
Illustration 9-15

9-34 LO 5 Determine ending inventory by applying the gross profit method.

 Gross Profit Method Illustration 9-16
Formulas Relating
to Gross Profit

Illustration 9-17
Application of Gross
Profit Formulas

9-35 LO 5
 Gross Profit Method

Illustration: Astaire Company uses the gross profit method to

estimate inventory for monthly reporting purposes. Presented below is
information for the month of May.

Inventory, May 1 $ 160,000

Purchases (gross) 640,000
Freight-in 30,000
Sales 1,000,000
Sales returns 70,000
Purchase discounts 12,000
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.
9-36 LO 5
 Gross Profit Method
(a) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of sales.

Inventory, May 1 (at cost) $ 160,000

Purchases (gross) (at cost) 640,000
Purchase discounts (12,000)
Freight-in 30,000
Goods available (at cost) 818,000
Sales (at selling price) $ 1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000
Less gross profit (25% of $930,000) 232,500
Sales (at cost) 697,500
Approximate inventory, May 31 (at cost) $ 120,500

9-37 LO 5 Determine ending inventory by applying the gross profit method.

 Gross Profit Method
(b) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of cost.

Inventory, May 1 (at cost) $ 160,000

Purchases (gross) (at cost) 25% 640,000
= 20% of sales
Purchase discounts 100% + 25% (12,000)
Freight-in 30,000
Goods available (at cost) 818,000
Sales (at selling price) $ 1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000
Less gross profit (20% of $930,000) 186,000
Sales (at cost) 744,000
Approximate inventory, May 31 (at cost) $ 74,000

9-38 LO 5 Determine ending inventory by applying the gross profit method.

 Gross Profit Method

Evaluation of Gross Profit Method

Disadvantages:

(1) Provides an estimate of ending inventory.

(2) Uses past percentages in calculation.

(3) A blanket gross profit rate may not be representative.

(4) Normally unacceptable for financial reporting purposes.

GAAP requires a physical inventory as additional
verification.

9-39 LO 5 Determine ending inventory by applying the gross profit method.


Managers and analysts closely follow gross
profits. A small change in the gross profit
rate can significantly affect the bottom line.
In 1993, Apple suffered a textbook case of
shrinking gross profits. In response to
pricing wars in the personal computer
market, Apple had to quickly reduce the
price of its signature Macintosh computers
—reducing prices more quickly than it could
reduce its costs. As a result its percent in
1992 to 40 percent in 1993. Though the
drop of 4 percent seems small, its impact
on the bottom line caused Apple’s stock
price to drop from $57 per share on June 1,
1993, to $27.50 by mid-July 1993. As
another, more recent example, Nike—the
largest global manufacturer of athletic
footwear—in a recent quarter reported
9-40
WHAT’S YOUR PRINCIPLE
THE SQUEEZE
earnings that indicated falling gross profit,
leading market analysts to adjust Nike’s
price downward. The cause—continuing
downward pressure on its gross profit. On
the positive side, an increase in the gross
profit rate provides a positive signal to the
market. For example, just a 1 percent boost
in Dr. Pepper’s gross profit rate cheered
the market, indicating the company was
able to avoid the squeeze of increased
commodity costs by raising its prices.
Source: Trefis, “Nike’s Earnings Reiterate Gross
Margin Pressure,” http://seekingalpha.com
(March 23, 2011); and D. Kardous, “Higher
Pricing Helps Boost Dr. Pepper Snapple’s Net,”
Wall Street Journal Online (June 5, 2008).
LO 5
 9 Inventories: Additional
Valuation Issues
LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:

1. Describe and apply the lower-of-cost-or- 5. Determine ending inventory by applying

market rule. the gross profit method.
2. Explain when companies value 6. Determine ending inventory by applying
inventories at net realizable value. the retail inventory method.
3. Explain when companies use the relative 7. Explain how to report and analyze
sales value method to value inventories. inventory.
4. Discuss accounting issues related to
purchase commitments.

9-41
 Retail Inventory Method

A method used by retailers, to value inventory without a

physical count, by converting retail prices to cost.
Requires retailers to keep:
(1) Total cost and retail value of goods purchased.

(2) Total cost and retail value of the goods available for sale.

(3) Sales for the period. Methods

Methods
Conventional
 Conventional Method
Method
Cost
 Cost Method
Method
LIFO
 LIFO Retail
Retail
Dollar-value
 Dollar-value LIFO
LIFO

9-42 LO 6 Determine ending inventory by applying the retail inventory method.

 Retail Inventory Method

Illustration: Fuque Inc. uses the retail inventory method to

estimate ending inventory for its monthly financial statements. The
following data pertain to a single department for the month of
October.

COST RETAIL Instructions:

Beg. inventory, Oct. 1 $ 52,000 $ 78,000
Prepare a schedule
Purchases 272,000 423,000
Freight in 16,600 computing estimate
Purchase returns 5,600 8,000 retail inventory using the
Additional markups 9,000 following methods:
Markup cancellations 2,000
(1) Conventional (LCM)
Markdowns (net) 3,600
Normal spoilage 10,000 (2) Cost
Sales 390,000

9-43 LO 6 Determine ending inventory by applying the retail inventory method.

 Retail Inventory Method
CONVENTIONAL Method:
Cost to
COST RETAIL Retail %
Beg. inventory $ 52,000 $ 78,000
Purchases 272,000 423,000
Freight in 16,600
Purchase returns (5,600) (8,000)
Markups, net 7,000
Current year additions 283,000 422,000
Goods available for sale 335,000 / 500,000 = 67.00%
Markdowns, net (3,600)
Normal spoilage (10,000)
Sales (390,000)
Ending inventory at retail $ 96,400

Ending inventory at Cost:

$ 96,400 x 67.00% = $ 64,588

9-44 LO 6 Determine ending inventory by applying the retail inventory method.

 Retail Inventory Method
COST Method:
Cost to
COST RETAIL Retail %
Beg. inventory $ 52,000 $ 78,000
Purchases 272,000 423,000
Freight in 16,600
Purchase returns (5,600) (8,000)
Markdowns, net (3,600)
Markups, net 7,000
Current year additions 283,000 / 418,400 =
Goods available for sale 335,000 496,400 67.49%
Normal spoilage (10,000)
Sales (390,000)
Ending inventory at retail $ 96,400

Ending inventory at Cost:

$ 96,400 x 67.49% = $ 65,056

9-45 LO 6 Determine ending inventory by applying the retail inventory method.

 Retail Inventory Method

Special Items Relating to Retail Method

 Freight costs
 Purchase returns
 Purchase discounts and allowances
 Transfers-in
When
When sales
sales are
are recorded
recorded
 Normal shortages
gross,
gross, companies
companies dodo not
not
 Abnormal shortages recognize
recognize sales
sales discounts.
discounts.
 Employee discounts

9-46 LO 6 Determine ending inventory by applying the retail inventory method.

 Retail Inventory Method

Special
Items

Illustration 9-23

9-47 LO 6
 Retail Inventory Method

Evaluation of Retail Inventory Method

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.

Some companies refine the retail method by computing inventory separately by

departments or class of merchandise with similar gross profits.

9-48 LO 6 Determine ending inventory by applying the retail inventory method.

 9 Inventories: Additional
Valuation Issues
LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:

1. Describe and apply the lower-of-cost-or- 5. Determine ending inventory by applying

market rule. the gross profit method.
2. Explain when companies value 6. Determine ending inventory by applying
inventories at net realizable value. the retail inventory method.
3. Explain when companies use the relative 7. Explain how to report and analyze
sales value method to value inventories. inventory.
4. Discuss accounting issues related to
purchase commitments.

9-49
 Presentation and Analysis

Presentation of Inventories
Accounting standards require disclosure of:
1) Composition of the inventory, inventory financing
arrangements, and the inventory costing methods
employed.

2) Consistent application of costing methods from one period

to another.

3) Inventory composition either in the balance sheet or in a

separate schedule in the notes.

9-50 LO 7 Explain how to report and analyze inventory.

 Presentation and Analysis

Presentation of Inventories
Accounting standards require disclosure of:
4) Significant or unusual financing arrangements relating to
inventories.

5) Inventories pledged as collateral for a loan in the current

assets section rather than as an offset to the liability.

6) Basis on which it states inventory amounts (lower of-cost-

or-market) and the method used in determining cost
(LIFO, FIFO, average cost, etc.).

9-51 LO 7 Explain how to report and analyze inventory.

 Presentation and Analysis

Presentation of Inventories
Illustration 9-24
Disclosure of Inventory
Methods

9-52 LO 7 Explain how to report and analyze inventory.

 Presentation and Analysis
Presentation of Inventories
9-53
Illustration 9-25
Disclosure of Trade
Practice in Valuing
Inventories
LO 7
 Presentation and Analysis

Analysis of Inventories
Common ratios used in the management and evaluation of
inventory levels are inventory turnover and average days
to sell the inventory.

9-54 LO 7 Explain how to report and analyze inventory.

 Presentation and Analysis

Inventory Turnover Ratio

Measures the number of times on average a company sells
the inventory during the period.

Illustration: In its 2011 annual report Kellogg Company reported

a beginning inventory of $1,056 million, an ending inventory of
$1,132 million, and cost of goods sold of $7,750 million for the
year. Illustration 9-26

9-55 LO 7 Explain how to report and analyze inventory.

 Presentation and Analysis

Average Days to Sell Inventory

Measure represents the average number of days’ sales for
which a company has inventory on hand.
Illustration 9-26

Average Days to Sell

365 days / 7.08 times = every 51.5 days

9-56 LO 7 Explain how to report and analyze inventory.

 APPENDIX 9A LIFO RETAIL METHODS

Primary reason to use LIFO

 Tax advantages.
 Results in a better matching of costs and revenues.
 The use of LIFO retail is made under two assumptions:

1. stable prices and

2. fluctuating prices.

9-57 LO 8 Determine ending inventory by applying the LIFO retail methods.

 APPENDIX 9A LIFO RETAIL METHODS

Stable Prices—LIFO Retail Method

A major assumption of the LIFO retail method is that the
markups and markdowns apply only to the goods purchased
during the current period and not to the beginning inventory.

9-58 LO 8 Determine ending inventory by applying the LIFO retail methods.

 APPENDIX 9A LIFO RETAIL METHODS

Illustration: Fuque Inc. uses the retail inventory method to

estimate ending inventory for its monthly financial statements. The
following data pertain to a single department for the month of
October.

COST RETAIL Instructions:

Beg. inventory, Oct. 1 $ 52,000 $ 78,000
Prepare a schedule
Purchases 272,000 423,000
Freight in 16,600 computing estimate
Purchase returns 5,600 8,000 retail inventory using the
Additional markups 9,000 LIFO Retail method.
Markup cancellations 2,000
Markdowns (net) 3,600
Normal spoilage 10,000
Sales 390,000

9-59 LO 8 Determine ending inventory by applying the LIFO retail methods.

 APPENDIX 9A LIFO RETAIL METHODS

LIFO Retail Method: Cost to

COST RETAIL Retail %
Beg. inventory $ 52,000 $ 78,000 66.67%
Purchases 272,000 423,000
Freight in 16,600
Purchase returns (5,600) (8,000)
Markdowns, net (3,600)
Markups, net 7,000
Current year additions 283,000 418,400 67.64%
Goods available for sale 335,000 / 496,400 =
Normal spoilage (10,000)
Sales (390,000)
Ending inventory at retail $ 96,400
Ending inventory at Cost:
$ 78,000 x 66.67% = $ 52,000
18,400 x 67.64% = $ 12,446
$ 96,400 $ 64,446
9-60 LO 8
 APPENDIX 9A LIFO RETAIL METHODS

Illustration 9A-1
LIFO Retail Method—Stable Prices

2014

9-61 LO 8 Determine ending inventory by applying the LIFO retail methods.

 APPENDIX 9A LIFO RETAIL METHODS

Illustration 9A-2
Ending Inventory at LIFO Cost, 2014—Stable Prices

Inventory is composed of two layers.

Advance slide
in presentation
mode to reveal
9-62 answers.
LO 8 Determine ending inventory by applying the LIFO retail methods.
 APPENDIX 9A LIFO RETAIL METHODS

Illustration 9A-3
Ending Inventory at LIFO Cost, 2015—Stable Prices

Notice that the 2014 layer is reduced from $11,000 to $5,000.

Advance slide
in presentation
mode to reveal
9-63 answers.
LO 8 Determine ending inventory by applying the LIFO retail methods.
 APPENDIX 9A LIFO RETAIL METHODS

Fluctuating Prices—Dollar-Value LIFO Retail

If the price level does change, the company must eliminate the
price change so as to measure the real increase in inventory,
not the dollar increase.

9-64 LO 8 Determine ending inventory by applying the LIFO retail methods.

 APPENDIX 9A LIFO RETAIL METHODS

Illustration: Assume that the beginning inventory had a retail

market value of $10,000 and the ending inventory had a retail
market value of $15,000. Assume further that the price level has
risen from 100 to 125. It is inappropriate to suggest that a real
increase in inventory of $5,000 has occurred. Instead, the company
must deflate the ending inventory at retail.
Illustration 9A-4

*1.25 = 125 ÷ 100

9-65 LO 8 Determine ending inventory by applying the LIFO retail methods.

 APPENDIX 9A LIFO RETAIL METHODS

Illustration: Assume that the current 2014 price index is 112

(prior year = 100) and that the inventory ($56,000) has remained
unchanged.

Illustration 9A-5
Dollar-Value LIFO Retail
Method—Fluctuating
Prices

9-66
 APPENDIX 9A LIFO RETAIL METHODS

Illustration: From this information, we compute the inventory amount

at cost:
Illustration 9A-6

Hernandez must restate layers of a particular year to the prices in

effect in the year when the layer was added.

9-67 LO 8 Determine ending inventory by applying the LIFO retail methods.

 APPENDIX 9A LIFO RETAIL METHODS

Difference between the LIFO approach (stable

Illustration 9A-7
prices) and the dollar-value LIFO method. Comparison of Effect of
Price Assumptions

The difference of $3,780 results from an increase in the price of

goods, not from an increase in the quantity of goods.

9-68 LO 8 Determine ending inventory by applying the LIFO retail methods.

 APPENDIX 9A LIFO RETAIL METHODS

Subsequent Adjustments under Dollar-Value

LIFO Retail
Illustration: Using the data from the previous example, assume that
the retail value of the 2015 ending inventory at current prices is
$64,800, the 2015 price index is 120 percent of base-year, and the
cost-to-retail percentage is 75 percent. Compute the ending inventory
at LIFO cost.
Illustration 9A-8

9-69 LO 8
 APPENDIX 9A LIFO RETAIL METHODS

Subsequent Adjustments under Dollar-Value

LIFO Retail
Illustration: Conversely assume that in 2015 the ending inventory in
base-year prices is $48,000. Compute the ending inventory at LIFO
cost.
Illustration 9A-9

9-70 LO 8 Determine ending inventory by applying the LIFO retail methods.

 APPENDIX 9A LIFO RETAIL METHODS

Changing from Conventional Retail to LIFO

Illustration: Hackman Clothing Store employs the conventional
retail method but wishes to change to the LIFO retail method
beginning in 2015. The amounts shown by the firm’s books are as
follows.

9-71 LO 8 Determine ending inventory by applying the LIFO retail methods.

 APPENDIX 9A LIFO RETAIL METHODS

Conventional Retail Inventory Method Illustration 9A-10

9-72 LO 8
 APPENDIX 9A LIFO RETAIL METHODS

Hakeman Clothing can then quickly approximate the ending inventory for
2014 under the LIFO retail method.
Illustration 9A-11

The difference of $500 ($11,250 - $10,750) between the LIFO retail

method and the conventional retail method is the amount by which the
company must adjust beginning inventory for 2015.

9-73 LO 8 Determine ending inventory by applying the LIFO retail methods.

 RELEVANT FACTS - Similarities
 IFRS and GAAP account for inventory acquisitions at historical cost and
evaluate inventory for lower-of-cost-or-market subsequent to acquisition.
 Who owns the goods—goods in transit, consigned goods, special sales
agreements—as well as the costs to include in inventory are essentially
accounted for the same under IFRS and GAAP.

LO 9 Compare the accounting procedures related to

9-74 valuation of inventories under GAAP and IFRS.
 RELEVANT FACTS - Differences
 The requirements for accounting for and reporting inventories are more
principles-based under IFRS. That is, GAAP provides more detailed
guidelines in inventory accounting.
 A major difference between IFRS and GAAP relates to the LIFO cost
flow assumption. GAAP permits the use of LIFO for inventory valuation.
IFRS prohibits its use. FIFO and average-cost are the only two
acceptable cost flow assumptions permitted under IFRS. Both sets of
standards permit specific identification where appropriate.
 In the lower-of-cost-or-market test for inventory valuation, IFRS defines
market as net realizable value. 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.
9-75 LO 9
 RELEVANT FACTS - Differences
 Under GAAP, if inventory is written down under the lower-of-cost-or-
market 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.
 IFRS requires both biological assets and agricultural produce at the point
of harvest to be reported at net realizable value. 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.
9-76 LO 9
 ON THE HORIZON
One issue that will be difficult to resolve relates to the use of the LIFO cost flow
assumption. As indicated, IFRS specifically prohibits its use. Conversely, the
LIFO cost flow assumption is widely used in the United States because of its
favorable tax advantages. In addition, many argue that LIFO from a financial
reporting point of view provides a better matching of current costs against
revenue and therefore enables companies to compute a more realistic income.

LO 9 Compare the accounting procedures related to

9-77 valuation of inventories under GAAP and IFRS.
 IFRS SELF-TEST QUESTION
All of the following are key similarities between GAAP and IFRS with
respect to accounting for inventories except:
a. costs to include in inventories are similar.
b. LIFO cost flow assumption where appropriate is used by both
sets of standards.
c. fair value valuation of inventories is prohibited by both sets of
standards.
d. guidelines on ownership of goods are similar.

LO 9 Compare the accounting procedures related to

9-78 valuation of inventories under GAAP and IFRS.
 IFRS SELF-TEST QUESTION
All of the following are key differences between GAAP and IFRS with
respect to accounting for inventories except the:
a. definition of the lower-of-cost-or-market test for inventory
valuation differs between GAAP and IFRS.
b. average cost method is prohibited under IFRS.
c. inventory basis determination for write-downs differs between
GAAP and IFRS.
d. guidelines are more principles based under IFRS than they are
under GAAP.

LO 9 Compare the accounting procedures related to

9-79 valuation of inventories under GAAP and IFRS.
 IFRS SELF-TEST QUESTION
Under IFRS, agricultural activity results in which of the following types
of assets?
I. Agricultural produce
II. Biological assets
a. I only.
b. II only.
c. I and II.
d. Neither I nor II.

LO 9 Compare the accounting procedures related to

9-80 valuation of inventories under GAAP and IFRS.
 Copyright

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9-81