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...and other contents.
Chapter 9-1 CHAPTER INVENTORIES: ADDITIONAL VALUATION ISSUES Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 9-2 Learning Objectives Learning Objectives Describe and apply the lowerofcostormarket 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 Determine ending inventory by applying the gross profit method Determine ending inventory by applying the retail inventory method Explain how to report and analyze inventory Chapter 9-3 Inventories: Additional Valuation Issues Inventories: Additional Valuation Issues Lower-ofCost-orMarket Ceiling and floor How LCM works Application of LCM “Market” Evaluation of rule Chapter 9-4 Valuation Bases Net realizable value Relative sales value Purchase commitments Gross Profit Method Gross profit percentage Evaluation of method Retail Inventory Method Concepts Conventional method Special items Evaluation of method Presentation and Analysis Presentation Analysis LowerofCostorMarket LowerofCostorMarket LCM A company abandons the historical cost principle when the future utility (revenueproducing ability) of the asset drops below its original cost Market = Replacement Cost Lower of Cost or Replacement Cost Loss should be recorded when loss occurs, not in the period of sale Chapter 9-5 LO 1 Describe and apply the lowerofcostormarket rule LowerofCostorMarket LowerofCostorMarket 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: Chapter 9-6 Ceiling net realizable value and Floor net realizable value less a normal profit margin LO 1 Describe and apply the lowerofcostormarket rule LowerofCostorMarket LowerofCostorMarket Illustration 93 What is the rationale for the Ceiling and Floor limitations? Ceiling = NRV Not > Cost Cost Market Market Replacement Cost Not < GAAP GAAP LCM LCM Chapter 9-7 Floor = NRV less Normal Profit Margin LO 1 Describe and apply the lowerofcostormarket rule LowerofCostorMarket LowerofCostorMarket Rationale for 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 Chapter 9-8 LO 1 Describe and apply the lowerofcostormarket rule LowerofCostorMarket LowerofCostorMarket How LCM Works (Individual Items) Illustration 95 Chapter 9-9 Solution on notes page LO 1 Describe and apply the lowerofcostormarket rule LowerofCostorMarket LowerofCostorMarket Methods of Applying LCM Illustration 96 Chapter 9-10 Solution on notes page LO 1 Describe and apply the lowerofcostormarket rule 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 Beginning inventory is excluded from the costtoretail percentage Chapter 9-45 LO 8 Determine ending inventory by applying the LIFO retail methods ILLUSTRATION 9A1 LIFO Retail Method—Stable Prices Chapter 9-46 LO 8 Determine ending inventory by applying the LIFO retail methods ILLUSTRATION 9A2 Ending Inventory at LIFO Cost, 2010—Stable Prices Inventory is composed of two layers Solution on notes page Chapter 9-47 LO 8 Determine ending inventory by applying the LIFO retail methods ILLUSTRATION 9A3 Ending Inventory at LIFO Cost, 2011—Stable Prices Assume that the ending inventory for 2011 at retail is $50,000. Notice that the 2010 layer is reduced from $11,000 to $5,000 Solution on notes page Chapter 9-48 LO 8 Determine ending inventory by applying the LIFO retail methods Fluctuating Prices—DollarValue 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 Chapter 9-49 LO 8 Determine ending inventory by applying the 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 9A4 Chapter 9-50 LO 8 Determine ending inventory by applying the LIFO retail methods Illustration: Assume that the current 2010 price index is 112 (prior year 100) and that the inventory ($56,000) has remained unchanged Illustration 9A5 DollarValue LIFO Retail Method—Fluctuating Prices Chapter 9-51 LO 8 Determine ending inventory by applying the LIFO retail methods Illustration: From this information, we compute the inventory amount at cost: Illustration 9A6 Hernandez must restate layers of a particular year to the prices in effect in the year when the layer was added Chapter 9-52 LO 8 Determine ending inventory by applying the LIFO retail methods Comparison of Effect of Price Assumptions Illustration 9A7 Chapter 9-53 LO 8 Determine ending inventory by applying the LIFO retail methods Subsequent Adjustments under DollarValue LIFO Retail Illustration: Using the data from the previous example, assume that the retail value of the 2011 ending inventory at current prices is $64,800, the 2011 price index is 120 percent of baseyear, and the costtoretail percentage is 75 percent. Compute the ending inventory at LIFO cost Illustration 9A8 Chapter 9-54 LO 8 Determine ending inventory by applying the LIFO retail methods Subsequent Adjustments under DollarValue LIFO Retail Illustration: Conversely assume that in 2011 the ending inventory in baseyear prices is $48,000. Compute the ending inventory at LIFO cost Illustration 9A9 Chapter 9-55 LO 8 Determine ending inventory by applying the LIFO retail methods Changing from Conventional Retail to LIFO Illustration: Clark Clothing Store employs the conventional retail method but wishes to change to the LIFO retail method beginning in 2010. The amounts shown by the firm’s books are as follows Chapter 9-56 LO 8 Determine ending inventory by applying the LIFO retail methods Illustration 9A10 Conventional Retail Inventory Method Chapter 9-57 Clark Clothing can then quickly approximate the ending inventory for 2010 under the LIFO retail method Illustration 9A11 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 2011 Chapter 9-58 LO 8 Determine ending inventory by applying the LIFO retail methods Copyright Copyright Copyright © 2009 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 Chapter 9-59 ... Explain how to report and analyze inventory Chapter 9-3 Inventories:? ?Additional? ?Valuation? ?Issues Inventories:? ?Additional? ?Valuation? ?Issues Lower-ofCost-orMarket Ceiling and floor How LCM works Application of LCM “Market” Evaluation.. .CHAPTER INVENTORIES: ADDITIONAL VALUATION ISSUES Intermediate? ?Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 9-2 Learning Objectives Learning Objectives... recognize losses in the period during which such declines in market prices take place Chapter 9-2 3 LO 4 Discuss? ?accounting? ?issues? ?related to purchase commitments Valuation? ?Bases Valuation? ?Bases Illustration: St. Regis Paper Co. signed timbercutting contracts to be