Lecture Intermediate accounting (IFRS 2nd edition): Chapter 9 - Kieso, Weygandt, Warfield

Chapter 9 - Inventories: Additional valuation issues. After completing this chapter you should be able to: Describe and apply the lower-of-cost-or-market rule, explain when companies value inventories at net realizable value, explain when companies use the relative sales value method to value inventories, discuss accounting issues related to purchase commitments.

Intermediate Accounting IFRS 2nd Edition

Kieso, Weygandt, and Warfield  

9

5 Determine ending inventory by applying  the gross profit method.

6 Determine ending inventory by applying  the retail inventory method.

7 Explain how to report and analyze  inventory.

After studying this chapter, you should be able to:

Inventories: Additional  Valuation Issues

LO 1

Illustration of LCNRV:   Jinn­Feng Foods computes its  inventory at LCNRV (amounts in thousands).

Determining Final  Inventory Value

Inventory  12,000 Cost of Goods Sold 12,000

Gross profit        92,000        80,000 Operating expenses:

Selling        45,000        45,000 General and administrative        20,000        20,000 Total operating expenses        65,000        65,000 Other income and expense:

Loss due to decline of inventory to NRV        12,000        ­ Interest income        5,000        5,000 Total other         (7,000)        5,000 Income from operations        20,000        20,000 Income tax expense        6,000        6,000 Net income €       14,000 €          14,000

Inventory €         70,000 €          82,000 Allowance to reduce inventory        (12,000)

Prepaids        20,000         20,000 Accounts receivable          350,000           350,000 Cash          100,000           100,000 Total current assets          540,000           540,000

LCNRV

1.A company recognizes decreases in the value of the asset and 

the charge to expense in the period in which the loss in utility occurs—not in the period of sale. 

2.Application of the rule results in inconsistency because a 

company may value the inventory at cost in one year and at net realizable value in the next year

3.LCNRV values the inventory in the statement of financial position 

conservatively, but its effect on the income statement may or may not be conservative. Net income for the year in which a company takes the loss is definitely lower. Net income of the subsequent period may be higher than normal if the expected reductions in sales price do not materialize

Evaluation of LCM Rule

Catalog selling price €    500 €    540 €    900 €   1,200 FIFO cost per inventory list 12/31/15       470       450       830         960 Estimated cost to complete and sell         50       110       260         200

5 Determine ending inventory by applying  the gross profit method.

6 Determine ending inventory by applying  the retail inventory method.

7 Explain how to report and analyze  inventory.

After studying this chapter, you should be able to:

Inventories: Additional  Valuation Issues

Illustration:  Bancroft Dairy produces milk for sale to local cheese­makers. Bancroft began operations on January 1, 2015, by 

LO 2

  Unrealized Holding Gain or Loss—Income  33,800

Inventory (milk) 36,000

Unrealized Holding Gain or Loss—Income

 36,000

Inventory (milk)  LO 2

LO 2

5 Determine ending inventory by applying  the gross profit method.

6 Determine ending inventory by applying  the retail inventory method.

7 Explain how to report and analyze  inventory.

After studying this chapter, you should be able to:

Inventories: Additional  Valuation Issues

ILLUSTRATION 9-10

Allocation of Costs, Using Relative Standalone Sales Value

ILLUSTRATION 9-11

Determination of Gross Profit,

Using Relative Standalone Sales Value

VALUATION BASES

5 Determine ending inventory by applying  the gross profit method.

6 Determine ending inventory by applying  the retail inventory method.

7 Explain how to report and analyze  inventory.

After studying this chapter, you should be able to:

Inventories: Additional  Valuation Issues

VALUATION BASES

Purchases (Inventory)  7,000,000

Purchase Commitment Liability   3,000,000

Cash 

10,000,000Assume Apres is permitted to reduce its contract price and 

5 Determine ending inventory by  applying the gross profit 

method.

6 Determine ending inventory by applying  the retail inventory method.

7 Explain how to report and analyze  inventory.

After studying this chapter, you should be able to:

Inventories: Additional  Valuation Issues

ESTIMATING INVENTORY

Illustration:   Astaire Company uses the gross profit method to 

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

    Goods available (at cost)         818,000  Sales (at selling price)  €    1,000,000 

    Goods available (at cost)         818,000  Sales (at selling price)  €    1,000,000 

Managers and analysts closely follow gross

profits A small change in the gross profit

rate can significantly affect the bottom line

For example, at one time, Apple Computer

(USA) 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 gross profit rate fell from 44

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 share price to drop from $57 per

share to $27.50 in just six weeks.

WHAT’S YOUR PRINCIPLE THE SQUEEZE

As another example, Debenham (GBR), the second largest department store in the United Kingdom, experienced a 14 percentage share price decline The cause? Markdowns on slow-moving inventory reduced its gross margin 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 (USA) gross profit rate cheered the market, indicating the company was able to avoid the squeeze of increased commodity costs by raising its prices.

Sources: Alison Smith, “Debenham’s Shares Hit

by Warning,” Financial Times (July 24, 2002), p

21; and D Kardous, “Higher Pricing Helps Boost

Dr Pepper Snapple’s Net,” Wall Street Journal

Online (June 5, 2008).

5 Determine ending inventory by applying  the gross profit method.

6 Determine ending inventory by  applying the retail inventory  method.

7 Explain how to report and analyze  inventory.

After studying this chapter, you should be able to:

Inventories: Additional  Valuation Issues

Method used by retailers to compile inventories at retail prices.  Retailer can use a formula to  convert retail prices to cost.

9-48 LO 6

Illustration:   The following data pertain to a single department for 

the month of October for Fuque Inc. Prepare a schedule computing retail inventory using the Conventional and Cost methods

RETAIL INVENTORY METHOD

COST RETAIL Beg. inventory, Oct. 1 £       52,000 £       78,000 Purchases        272,000        423,000 Freight in          16,600

Purchase returns        5,600        8,000 Additional markups        9,000 Markup cancellations        2,000 Markdowns (net)        3,600 Normal spoilage and breakage          10,000

Cost to COST RETAIL Retail % Beginning inventory £        52,000 £       78,000

RETAIL INVENTORY METHOD

LO 6

Cost to COST RETAIL Retail % Beginning inventory £        52,000 £       78,000

RETAIL INVENTORY METHOD

RETAIL INVENTORY METHOD

5 Determine ending inventory by applying  the gross profit method.

6 Determine ending inventory by applying  the retail inventory method.

7 Explain how to report and  analyze inventory.

After studying this chapter, you should be able to:

Inventories: Additional  Valuation Issues

3) Carrying amount of inventories carried at fair value less 

costs to sell. 

4) Amount of inventories recognized as an expense during the 

INVENTORIES

In most cases, IFRS and U.S GAAP related to inventory are the same The major differences are that IFRS prohibits the use of the LIFO cost flow assumption and records market in the LCNRV differently.

GLOBAL ACCOUNTING INSIGHTS

Relevant Facts

Following are the key similarities and differences between U.S GAAP and IFRS related to inventories

Similarities

and evaluate inventory for lower-of-cost-or-net realizable value (market) subsequent to acquisition.

agreements—as well as the costs to include in inventory are essentially accounted for the same under U.S GAAP and IFRS.

GLOBAL ACCOUNTING INSIGHTS

Relevant Facts

Differences

requirements for accounting for and reporting inventories are more principles-based under IFRS.

flow assumption U.S 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.

GLOBAL ACCOUNTING INSIGHTS

Relevant Facts

Differences

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 defines market as net realizable value and does not use a ceiling or a floor to determine market

lower-of-cost-or-market valuation, the new basis is now considered its cost As a result, the inventory may not be written up back 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.

GLOBAL ACCOUNTING INSIGHTS

Relevant Facts

Differences

harvest to be reported at 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.

GLOBAL ACCOUNTING INSIGHTS

About The Numbers

Presented below is a disclosure under U.S GAAP related to inventories, which reflects application of U.S GAAP to its inventories.

GLOBAL ACCOUNTING INSIGHTS

On the Horizon

One convergence 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.

GLOBAL ACCOUNTING INSIGHTS

Copyright  ©  2014  John  Wiley  &  Sons,  Inc.  All  rights  reserved. Reproduction  or  translation  of  this  work  beyond  that  permitted  in Section  117  of  the  1976  United  States  Copyright  Act  without  the express  written  permission  of  the  copyright  owner  is  unlawful. Request  for  further  information  should  be  addressed  to  the Permissions Department,  John  Wiley  & Sons, Inc. The purchaser may  make  back­up  copies  for  his/her  own  use  only  and  not  for distribution or resale. The Publisher assumes no responsibility for errors,  omissions,  or  damages,  caused  by  the  use  of  these programs or from the use of the information contained herein.

COPYRIGHT