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Inventory Valuation at Other Than Cost

Inventory Valuation at Other Than Cost. Learning Objectives. Apply the lower-of-cost-or-market (LCM) rule to reflect declines in the market value of inventory. Use the gross profit method to estimate ending inventory.

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Inventory Valuation at Other Than Cost

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  1. Inventory Valuation at Other Than Cost

  2. Learning Objectives • Apply the lower-of-cost-or-market (LCM) rule to reflect declines in the market value of inventory. • Use the gross profit method to estimate ending inventory. • Compute estimates of FIFO, LIFO, average cost, and lower-of-cost-or-market inventory using the retail inventory method.

  3. Learning Objectives • Determine the financial statement impact of inventory recording errors. EXPANDEDMATERIAL • Combine the retail inventory method and dollar-value LIFO to compute ending inventory using the dollar-value LIFO retail method.

  4. Learning Objectives • Account for the impact of changing prices on purchase commitments. • Record inventory purchase transactions denominated in foreign currencies.

  5. Inventory Estimation Methods Methods for valuing inventory at other than cost • Lower-of-Cost-or-Market Method • Gross Profit Method • Retail Inventory Method • Dollar-Value LIFO Retail Method

  6. Lower of Cost or Market (LCM) What is market?

  7. Lower of Cost or Market (LCM) In lower of cost or market, market means replacement cost within limits.

  8. Lower of Cost or Market (LCM) • When goods remaining in inventory can be replaced with identical goods at a lower cost, the lower (market) cost must be used to value the inventory. • What are the replacement cost limits? • Upper limit: Net realizable value. • Lower limit: Net realizable value minus a normal profit.

  9. LCM Examples A company’s unit of inventory has the following characteristics: Selling price $165 Packaging cost 10 Transportation cost 15 Profit margin 40

  10. LCM Examples Net realizable value Selling price $165 Cost of completion (10) Transportation cost (15) Ceiling (NRV) $140 Ceiling (NRV) $140 Normal profit (40) Floor $100 Example 1 Normal Profit = $40

  11. LCM Examples Selling price $165 Cost of completion (10) Transportation cost (15) Ceiling (NRV) $140 Ceiling (NRV) $140 Normal profit (40) Floor $100 Cost $155 Normal Profit = $40 Current Replacement Cost, $150 Market $140 LCM is market, $140

  12. LCM Examples Selling price $165 Cost of completion (10) Transportation cost (15) Ceiling (NRV) $140 Ceiling (NRV) $140 Normal profit (40) Floor $100 Example 2 Cost $110 Normal Profit = $40 Current Replacement Cost, $120 Market $120 LCM is cost, $110

  13. LCM Example Selling price $165 Cost of completion (10) Transportation cost (15) Ceiling (NRV) $140 Ceiling (NRV) $140 Normal profit (40) Floor $100 Example 3 Cost $110 Normal Profit = $20 Current Replacement Cost, $75 Market $100 LCM is market, $100

  14. Recording LCM Revaluations • LCM may be applied to each individual inventory item or to the inventory as a whole. • If LCM is applied to individual items, the difference between cost and market is credited directly to Inventory. • If LCM is applied to the inventory as a whole, the difference is recorded in an allowance account.

  15. LCM--Example: Recording Revaluation (data for valuation) Total Cost Ind Mkt Original Cost Market Qty Item LCM LCM A 20 $10 $200 $11 $200 $220 B 10 $10 $100 $9 $90 $90 C 10 $10 $100 $8 $80 $80 D 20 $10 $200 $9 $180 $180 $600 $550 $570

  16. LCM--Example: Recording Revaluation (applied individually) Total Cost Ind Mkt Original Cost Market Qty Item LCM LCM $50 A 20 $10 $200 $11 $200 $220 B 10 $10 $100 $9 $90 $90 C 10 $10 $100 $8 $80 $80 D 20 $10 $200 $9 $180 $180 $600 $550 $570 Journal Entry Loss from Decline in Value of Inventory..... 50 Inventory............................................ 50

  17. LCM--Example: Recording Revaluation (applied as a whole) Total Cost Ind Mkt Original Cost Market Qty Item LCM LCM $30 A 20 $10 $200 $11 $200 $220 B 10 $10 $100 $9 $90 $90 C 10 $10 $100 $8 $80 $80 D 20 $10 $200 $9 $180 $180 $600 $550 $570 Journal Entry Loss from Decline in Value of Inventory.............. 30 Allowance for Decline in Value of Inventory.. 30

  18. Gross Profit Method The gross profit method is an estimation technique to determine the inventory count... • when a physical count is not practical, and • as a validity check.

  19. Gross Profit Method Steps • Determine gross profit percentage. • Determine estimated sales. • Determine estimated cost of goods sold. • Determine estimated goods available for sale. • Determine estimated inventory.

  20. Gross Profit Method--Example: Basic Data Use the following information to estimate ending inventory: • Gross Profit Percentage 50% of sales • Accounts Receivable Collections $ 5,000 • Ending Accounts Receivable $ 1,000 • Beginning Accounts Receivable $ 2,000 • Beginning Inventory $ 6,000 • Payments to Suppliers $ 10,000 • Ending Accounts Payable $ 3,000 • Beginning Accounts Payable $ 1,000

  21. Gross Profit Method--Solution Step No.1 Determine Gross Profit Percentage Given as 50%, and management does not feel any changes are warranted.

  22. Gross Profit Method--Solution Accounts receivable collections $ 5,000 Add ending accounts receivable 1,000 $ 6,000 Deduct beginning accounts receivables(2,000) Estimated sales $ 4,000 Step No.2 Determine Estimated Sales

  23. Gross Profit Method--Solution Step No. 3 Determine Estimated Cost of Goods Sold Estimated sales $ 4,000 Times gross profit percentage x 50% Estimated cost of goods sold $ 2,000

  24. Gross Profit Method--Solution Beginning inventory $ 6,000 Add payments to suppliers $10,000 Add ending accounts payable 3,000 $13,000 Deduct beginning accts. pay. (1,000) Estimated purchases12,000 Estimated goods available for sale $18,000 Step No. 4 Determine Estimated Goods Available for Sale

  25. Gross Profit Method--Solution Step No.5 Determine Estimated Inventory Estimated goods available for sale $18,000 Estimated cost of goods sold 2,000 Estimated inventory $16,000

  26. Gross Profit Method Cost of Goods Available for Sale Sales Estimated Cost of Goods Sold Estimated Cost of Goods Sold Estimated Ending Inventory Estimated Gross Profit

  27. Salad Oil Swindle Tino DeAngelis rented a petroleum tank farm in Bayonne, New Jersey.

  28. Salad Oil Swindle He convinced auditors, investors, and investment bankers that the tanks contained $100 million in vegetable oil.

  29. Salad Oil Swindle The tanks actually were primarily filled with sea water. There was very little vegetable oil in the tanks.

  30. Salad Oil Swindle Tino would pump vegetable oil from one tank to another, depending on his advance knowledge of the auditor’s verification plan.

  31. Retail Inventory Method 1. Determine goods available for sale at cost and retail. 2. Determine cost percentage. 3. Determine ending inventory at retail. 4. Determine ending inventory at cost.

  32. Retail Inventory Method--Different Cost Methods Lower-of-Cost-or-MarketApproximation: Markups but not markdowns are included in the calculation of goods available for sale. Average Cost Method: Markups and markdowns are included in calculation of goods available for sale.

  33. Retail Inventory Method-- Example Use the following information to estimate ending inventory: Cost Retail Beginning inventory $1,000 $2,000 Purchases 5,000 8,000 Markups 2,000 Sales 6,000 Markdowns 600

  34. Retail Inventory Method--Solution for LCM Approximation Step No.1 Determine Goods Available for Sale at Cost and Retail--LCM Approximation CostRetail Beginning inventory $1,000 $ 2,000 Purchases 5,000 8,000 Markups 2,000 Goods available for sale $6,000 $12,000

  35. Retail Inventory Method--Solution for LCM Approximation Step No. 2 Determine Cost Percentage Goods available for sale at cost $ 6,000 Divided by goods available for sale 12,000 Cost percentage 50%

  36. Retail Inventory Method--Solution for LCM Approximation Step No.3 Determine Ending Inventory at Retail Goods available for sale $12,000 Less sales (6,000) Less markdowns (600) Ending inventory at retail $ 5,400

  37. Retail Inventory Method--Solution for LCM Approximation Step No.4 Determine Ending Inventory at Cost Ending Inventory at Retail $5,400 Times Cost Percentage x 50% Ending Inventory at Cost $2,700

  38. Retail Inventory Method--Solution for Average Cost Method Step No.1 Determine Goods Available for Sale CostRetail Beginning inventory $1,000 $ 2,000 Purchases 5,000 8,000 Markups 2,000 Markdowns (600) Goods available for sale $6,000 $11,400

  39. Retail Inventory Method--Solution for Average Cost Method Step No. 2 Determine Cost Percentage Goods available for sale at cost $ 6,000 Divided by goods available for sale at retail 11,400 Cost percentage 52.6%

  40. Retail Inventory Method--Solution for Average Cost Method Step No. 3 Determine Ending Inventory at Retail Goods available for sale $11,400 Less sales (6,000) Less markdowns (600) Ending inventory at retail $ 4,800

  41. Retail Inventory Method--Solution for Average Cost Method Step No.4 Determine Ending Inventory at Cost Ending inventory at retail $4,800 Times cost percentage x 52.6% Ending inventory at cost $2,525

  42. Retail Inventory Method Estimated Ending Inventory at Retail Less Sales To calculation of cost percentage Goods Available for Sale: At Retail Continued Beginning Inventory + Purchases = Goods Available for Sale

  43. Retail Inventory Method To calculation of cost percentage Continued Goods Available for Sale: At Cost Beginning Inventory + Purchases = Goods Available for Sale

  44. Retail Inventory Method Cost Percentage: Cost/Retail x Cost Percentage Estimated Ending Inventory at Cost Estimated Ending Inventory at Retail

  45. Retail Inventory Method • Freight-in is added to the cost of purchases. • Purchase discounts are subtracted from the cost of purchases. • Purchase returns are subtracted from both the cost and retail amount of purchases. • Purchase allowances normally are subtracted only from the cost of purchases. • Sales returns are subtracted from retail sales. • Sales discounts and sales allowances are not subtracted from retail sales.

  46. Dollar-Value LIFO Retail Inventory Method Steps 1. Determine inventory at base-year retail prices. 2. Determine dollar-value LIFO inventory layers at retail. 3. Determine dollar-value LIFO inventory layers at cost.

  47. Dollar-Value LIFO RetailInventory Method--Example Use the following data to estimate Ending Inventory for 2000, 2001, and 2002 (assume 1999 is the base year). Inventory at Year-End Incremental Year-End Year Price IndexCost PercentageRetail Prices 1999 1.00 .60 $60 2000 1.05 .62 $69 2001 1.10 .64 $77 2002 1.12 .65 $71

  48. Dollar-Value LIFO RetailInventory Method--Example Dollar- Inv @ Value Inv @ Base- Incr. Incr. LIFO EoY Price Year Layer Cost Retail Year Retail Index Retail Layers Index % Cost 1999 $60 ÷ 1.00 = $60

  49. Dollar-Value LIFO RetailInventory Method--Example Dollar- Inv @ Value Inv @ Base- Incr. Incr. LIFO EoY Price Year Layer Cost Retail Year Retail Index Retail Layers Index % Cost 1999 $60 ÷ 1.00 = $60 $60 x 1.00 x 0.60 = $36

  50. Dollar-Value LIFO RetailInventory Method--Example Dollar- Inv @ Value Inv @ Base- Incr. Incr. LIFO EoY Price Year Layer Cost Retail Year Retail Index Retail Layers Index % Cost 1999 $60 ÷ 1.00 = $60 $60 x 1.00 x 0.60 = $36 2000 $69 ÷ 1.05 = $66

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