Valuation and Reporting of Receivables and Inventory

1. Valuation and Reporting of Receivables and Inventory Chapter 6

2. Uncollectible Receivables • The matching principle requires that the expense related to uncollectible receivables must be recorded in the same period as the related revenue • Often requires an estimate of uncollectible receivables • Sale may be made in one period, but the uncollectible receivable is not identified until a later period

3. Uncollectible Receivables • Balance sheet presentation requires reporting of the estimated value of the receivables that will be collected (net realizable value) • An allowance for doubtful accounts is used to estimate the amount of receivables that will not be collected • Usually do not know which receivables will be uncollectible • The allowance is offset against the receivable account

4. Uncollectible Receivables • Estimation methods • Percent of sales method • Bad debt expense is calculated as a percent of credit sales made during the period • The expense increases the allowance for doubtful accounts • Percent of receivables method • The required allowance for doubtful accounts is calculated as the percent of receivables that are expected to be uncollectible (aging) • Bad debt expense is the amount required to bring the allowance up to its required balance

5. Uncollectible Receivables • Recording bad debt expense at year-end increases the allowance account and reduces retained earnings • It does not affect accounts receivable • Writing off a customer’s account reduces accounts receivable and the allowance • It does not affect bad debt expense • Net realizable value of receivables is the same after the writeoff as it was before

6. Valuation of Inventory • Inventory valuation relies on estimates since it is often impossible to determine exactly which goods have been sold and which remain in inventory • Cost flow assumptions • Specific identification • Weighted average • First-in, first-out (FIFO) • Last-in, first-out (LIFO)

7. Valuation of Inventory • Specific identification • Can specifically identify which goods remain, and match them to their cost • No estimate is needed • Weighted average cost • Determine the average cost of all goods available for sale • Total cost / total units

8. Inventory Valuation • First-in, first-out • Assumes oldest goods are sold first, newer ones remain in inventory • Assigns the oldest costs to the income statement • May understate cost of merchandise sold • Assigns the newest costs to the balance sheet • Provides good estimate of replacement cost of inventory

9. Inventory Valuation • Last-in, first-out • Assumes newest goods are sold first, oldest ones remain in inventory • Assigns most recent costs to the income statement • Good matching of cost to revenue, except when old units are sold • Assigns oldest costs to balance sheet • May understate inventory value

10. Inventory Valuation • Example

11. Inventory Valuation • Weighted average cost • $2,608 / 400 units = $6.52 per unit • Ending inventory • 110 units @ $6.52 = $717.20 • Cost of merchandise sold • 290 units @ $6.52 = $1,890.80

12. Inventory Valuation • First-in, first-out • Ending inventory • Cost of merchandise sold

13. Inventory Valuation • Last-in, first-out • Ending inventory • Cost of merchandise sold

14. Inventory Valuation • Lower of cost or market rule • Inventory is reported at cost unless • The replacement cost is below the recorded cost, or • The items cannot be sold at their normal selling price • Cost, as determined by one of the cost flow assumptions, is compared to the market value • Whichever is lower is the amount reported on the financial statements • Avoids overstating the value of inventory