Lecture Intermediate accounting (IFRS/e) - Chapter 9: Inventories: additional issues

In this chapter we complete our discussion of inventory measurement by explaining the lower-of-cost-or-market rule used to value inventories. In addition, we investigate inventory estimation techniques, methods of simplifying LIFO, changes in inventory method, and inventory errors.

Chapter INVENTORIES: ADDITIONAL ISSUES © 2013 The McGraw-Hill Companies, Inc Reporting Lower of Cost or Market Inventories are valued at the lowerof-cost-or market LCM LCM is is aa departure departure from from historical historical cost cost The The method method causes causes losses losses to to be be recognized recognized in in the the period period the the value value of of inventory inventory declines declines below below its its cost cost rather rather than than in in the the period period that that the the goods goods ultimately ultimately are are sold sold 9-2 Determining Market Value  IAS IAS No No 22 defines defines “market “market value” value” as as the the net net realizable realizable value value (NRV) (NRV)  NRV NRV isis the the estimated estimated selling selling price price in in the the ordinary ordinary course course of of business business less less estimated estimated cost cost of of completion completion and and disposal disposal (cost (cost to to sell) sell) 9-3 + Estimated selling price − Cost of Completion − Cost to sell = Net Realizable Value / Market Value Determining Market Value Step Determine Designated Market (1) (1) Selling Selling Price Price in in ordinary ordinary course course of of business business Step Compare Designated Market with Cost (3) (3) Net Net Realizable Realizable Value Value Designated Designated Market Market (2) (2) less: less: Estimated Estimated cost cost of of completion completion and and disposal disposal 9-4 Or Lower Lower of of Cost Cost Or Or Market Market Cost Cost 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 • How would we value this item in the statement of financial position? 9-5 Lower of Cost or Market Designated $21.50 Market? Historical cost of $20.00 is less than the NRV of 26, so this inventory item will be valued at cost of $20.00 9-6 Applying Lower of Cost or Market Lower of cost or market can be applied different ways 1) Individual Items LCM LCM to to individual inventory item 1) Individual Items Apply Apply Apply Apply LCM LCM to each each to logical logical individual inventory item in in categories inventory 2) or categories inventory 2) Group Group of of similar similar or related related inventory inventory items items 9-7 Adjusting Cost to Market Record the Loss as a Separate Item in the Income Statement Loss on write-down of inventory Inventory XX XX Record the Loss as part of Cost of Goods Sold Cost of goods sold Inventory 9-8 XX XX 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 • LCM requires selecting market from replacement cost, net realizable value or NRV reduced by the normal profit margin • Designated market is compared to historical cost to determine LCM - 10 • IAS No 2, states that the designated market will always be net realizable value Lower of Cost or Market Replacement Replacement Cost=$21.50 =$21.50 Cost Designated $21.50 Market? Historical cost of $20.00 is less than designated market of $21.50, so this inventory item will be valued at cost of $20.00 - 41 LIFO Retail    Method Appendix 9B - 42 The Retail Inventory Method The LIFO Retail Method • Assume that retail prices of goods remain stable during the period • Establish a LIFO base layer (beginning inventory) and add (or subtract) the layer from the current period • Calculate the cost-to-retail percentage for beginning inventory and for adjusted net purchases for the period - 43 The Retail Inventory Method The LIFO Retail Method LIFO Cost- = to-Retail % Net Purchases Retail Value (Net Purchases + Net Markups - Net Markdowns) Beginning inventory has its own cost-to-retail percentage - 44 Retail Inventory Method LIFO Retail - 45 Retail Inventory Method LIFO Retail - 46 Retail Inventory Method LIFO Retail Beginning Inventory Current Period's Layer Total ** rounded - 47 Retail $ 35,000 x 60.00% = 8,000 x 64.94% = $ 43,000 Cost 21,000 5,195 ** 26,195 Dollar-Value    LIFO Retail Appendix 9C - 48 Dollar-Value LIFO Retail We need to eliminate the effect of any price changes before we compare the ending inventory with the beginning inventory - 49 Dollar-Value LIFO Retail Return to our earlier Matrix Inc example to estimate the ending inventory using dollar-value LIFO retail Recall that ending inventory was estimated to be $35,000 at retail, and $21,000 at cost with a 60% gross profit ratio Net Net purchases purchases at at cost cost $200,000, $200,000, at at retail retail $304,000 $304,000 Net Net markups markups $8,000 $8,000 Net Net markdowns markdowns $4,000 $4,000 Net Net sales sales for for June June $300,000 $300,000 Price index at June is 100 and at June 30 the index is 102 - 50 Dollar-Value LIFO Retail - 51 Purchase    Commitments Appendix 9D - 52 Purchase Commitments Purchase commitments are contracts that obligate a company to purchase a specified amount of merchandise or raw materials at specified prices on or before specified dates In July 2013, the Lassiter Company signed two purchase commitments The first requires Lassiter to purchase inventory for $500,000 by November 15, 2013 The inventory is purchased on November 14, and paid for on December 15 On the date of acquisition, the inventory had a market value of $425,000 The second requires Lassiter to purchase inventory for $600,000 by February 15, 2014 On December 31, 2013, the market value of the inventory items was $540,000 On February 15, 2014, the market value of the inventory items was $510,000 Lassiter uses the perpetual inventory system and is a calendar year-end company Let’s make the journal entries for these commitments - 53 Purchase Commitments November 14, 2013 Inventory (market price) Loss on purchase commitment Accounts payable 425,000 75,000 December 15, 2013 Accounts payable Cash 500,000 500,000 500,000 December 31, 2013 Estimated loss on commitment 60,000 Estimated liability on commitment February 15, 2014 Inventory (market price) Loss on purchase commitment Estimated liability on commitment Cash - 54 Single-period commitment 60,000 Multi-period commitment 510,000 30,000 60,000 600,000 End of Chapter 9 - 55 ... the cost-to-retail percentage shown below: Net Markdowns are excluded in the computation of the cost-to-retail percentage This is referred to as the Conventional Retail Method - 27 Other Issues. .. Before calculating the cost-to-retail percentage Freight-in Purchase returns Purchase discounts taken Abnormal shortage, spoilage, or theft After calculating the cost-to-retain percentage Normal... is reasonably reasonably constant constant in in the the short-run short-run Beginning Inventory (from accounting records) (from accounting records) Plus: Net purchases Goods available for sale