Kế toán, kiểm toán - Chapter 9: Inventories: Additional issues

Inventories: Additional Issues9 Learning ObjectiveUnderstand and apply the lower-of-cost-or-market rule used to value inventories.LO1Lower of Cost or Market (LCM)GAAP requires that inventories be carried at cost or current market value, whichever is lower.LCM is a departure from historical cost and is a conservative accounting method.Determining Market ValueNet RealizableValue (Ceiling)Net Realizable Value less Normal Profit (Floor)Market value is NOT necessarily the amount for which inventory can be sold.Accounting Research Bulletin No. 43 defines “market value” in terms of current replacement cost.Determining Market ValueNet RealizableValue (Ceiling)Net Realizable Value less Normal Profit (Floor)Net Realizable Value (NRV) is the estimated selling price less cost of completion and disposal.ReplacementCostThe definition of market value varies internationally. In many countries, for example New Zealand market value is defined as NRV.Determining Market ValueNet Realizable Value less Normal Profit (Floor)Net RealizableValue (Ceiling)If replacement cost > Ceiling, then Ceiling = Market ValueReplacementCostIf replacement cost < Floor, then Floor = Market ValueLower of Cost or MarketAn item in inventory is currently carried at historical cost of $20 per unit. At year-end we gather the following per unit information: current replacement cost = $21.50selling price = $30cost to complete and dispose = $4 normal profit margin of = $5How would we value this item in the Balance Sheet?Lower of Cost or MarketNet RealizableValue (Ceiling)Net Realizable Value less Normal Profit (Floor)ReplacementCost =$21.50 Which one do we use?Market value = $21.50Cost = $20.00Should the inventory be recorded at cost or market?Market value = $21.50Cost = $20.00Since Cost < Market, the LCM rule would dictate that inventory be recorded at Cost.Lower of Cost or MarketNet RealizableValue (Ceiling)Net Realizable Value less Normal Profit (Floor)ReplacementCost =$21.50 In this case, market value will be $21.50 because the replacement cost is between the ceiling and the floor.Lower of Cost or MarketAn inventory item is currently carried at historical cost of $95.00 per unit. At the Balance Sheet date we gather the following per unit information: current replacement cost = $80.00NRV = $100.00NRV reduced by normal profit = $85.00How would we value the item on our Balance Sheet?Lower of Cost or MarketNet Realizable Value less Normal Profit (Floor) = $85Net Realizable Value (Ceiling) = $100ReplacementCost =$80 ???Which one do we use as market value?Lower of Cost or MarketShould the inventory be carried at Market Value or Cost?Market = $85 < Cost = $95Our inventory item will be written down to the Market Value $85.Net Realizable Value less Normal Profit (Floor) = $85Net Realizable Value (Ceiling) = $100ReplacementCost =$80 1. Apply LCM to each individual item in inventory. 2. Apply LCM to each class of inventory. 3. Apply LCM to the entire inventory as a group. Applying Lower of Cost or MarketLower of cost or market can be applied 3 different ways. Adjusting Cost to Market - OptionsRecord the Loss as a Separate Item in the Income StatementAdjust inventory directly or by using an allowance account.Record the Loss as part of Cost of Good SoldAdjust inventory directly or by using an allowance account.Learning ObjectiveEstimate ending inventory and cost ofgoods sold using the gross profit method.LO2Inventory Estimation TechniquesEstimate instead of taking physical inventory Less costly Less time consumingTwo popular methods are . . .Gross Profit MethodRetail Inventory MethodGross Profit MethodUseful when . . .Estimating inventory & COGS for interim reports.Determining the cost of inventory lost, destroyed, or stolen.Auditors are testing the overall reasonableness of client inventories.Preparing budgets and forecasts.NOTE: The Gross Profit Method is not acceptable for use in annual financial statements.Gross Profit MethodThis method assumes that the historical gross margin rate is reasonably constant in the short run.Cost of beginning inventory.Net purchases for the period.Historical gross margin rate.Net sales for the period.We need to know . . .Steps to the Gross Profit MethodEstimate Historical Gross Margin %.Sales x (1 - Estimated Gross Margin %) = Estimated COGSBeg. Inventory + Net Purchases = Cost of Goods Available for Sale (COGAS)COGAS - Estimated COGS = Estimated Cost of Ending InventoryGross Profit Method Matrix, Inc. uses the gross profit method to estimate end of month inventory. At the end of May, the controller has the following data: Net sales for May = $1,213,000Net purchases for May = $728,300Inventory at May 1 = $237,400 Gross margin = 43% of sales Estimate Inventory at May 31.Gross Profit Method NOTE: The key to successfully applying this method is a reliable Gross Margin Percentage.Learning ObjectiveEstimate ending inventory and cost ofgoods sold using the retail inventory method,LO3Retail Inventory MethodThis method was developed for retail operations like department stores.Uses both the retail value and cost of items for sale to calculate a cost to retail ratio.Objective: Convert ending inventory at retail to ending inventory at cost.Retail Inventory MethodWe need to know . . .Sales for the period.Beginning inventory at retail and cost.Adjustments to the original retail price.Net purchases at retail and cost.Steps to the Retail Inventory MethodDetermine cost and retail value of goods sold.Calculate the cost-to-retail %. Retail value of goods available for sale - sales = ending inventory at retail.Cost-to-retail % x Ending inventory at retail = Estimated ending inventory at cost.Retail Inventory MethodMatrix, Inc. uses the retail method to estimate inventory at the end of each month. For the month of May the controller gathers the following information: Beg. inventory at cost $27,000(at retail $45,000)Net purchases at cost $180,000(at retail $300,000)Net sales for May $310,000.Estimate the inventory at May 31.Retail Inventory MethodRetail Inventory MethodxApproximating Average CostThe primary difference between this and our earlier, simplified example, is the inclusion of markups and markdowns in the computation of the Cost-to-Retail %.Retail Inventory Method - Average CostMatrix, Inc. uses the average cost retail method to estimate inventory at the end of June. The controller gathers the following information: Beginning inventory at cost $21,000(at retail $35,000)Net purchases at cost $200,000(at retail $304,000)Net markups $8,000Net markdowns $4,000Net sales for June $300,000Estimate inventory at June 30.Retail Inventory Method - Average CostRetail Inventory Method - Average CostxLearning ObjectiveExplain how the retail inventory methodcan be made to approximate thelower-of-cost-or-market rule.LO4Retail Inventory Method - Average LCMApproximating Average LCMNet Markdowns are excluded in the computation of the Cost-to-Retail %Retail Inventory Method - Average LCMMatrix, Inc. uses the average cost retail method to estimate inventory at the end of June. The controller gathers the following information: Beginning inventory at cost $21,000(at retail $35,000)Net purchases at cost $200,000(at retail $304,000)Net markups $8,000Net markdowns $4,000Net sales for June $300,000Let’s estimate inventory at June 30.Retail Inventory Method - Average LCMRetail Inventory Method - Average LCMxThe LIFO Retail MethodAssume 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. The LIFO Retail MethodBeginning inventory has its owncost-to-retail percentage.The LIFO Retail MethodUse the data from Matrix Inc. to estimate the LIFO ending inventory. Beginning inventory at cost $21,000, at retail $35,000;Net purchases at cost $200,000, at retail $304,000;Net markups $8,000; Net markdowns $4,000; Net sales for June $300,000.Estimate ending inventory.The LIFO Retail MethodOther Issues of Retail Method Purchase returns and purchase discounts. Freight-in. Employee discounts. Spoilage, breakage, and theft.Learning ObjectiveDetermine ending inventory using thedollar-value LIFO retail inventorymethod.LO5Dollar-Value LIFO RetailWe need to eliminate the effect of any price changes before we compare the ending inventory with the beginning inventory.Dollar-Value LIFO RetailUse the data from Matrix Inc. to estimate the LIFO ending inventory. Beginning inventory at cost $21,000(at retail $35,000)Net purchases at cost $200,000(at retail $304,000)Net markups $8,000Net markdowns $4,000Net sales for June $300,000Price index at June 1 is 100 and at June 30the index is 102. Estimate ending inventory.Dollar-Value LIFO RetailLearning ObjectiveExplain the appropriate accountingtreatment required when a changein inventory method is made.LO6Changes in Inventory MethodRecall that most voluntary changes in accounting principles are reported retrospectively. This means reporting all previous periods’ financial statements as though the new method had been used in all prior periods.Changes in inventory methods, other than a change to LIFO, are treated retrospectively.FIFOLIFOChange toChange fromRetrospectiveChange To The LIFO MethodWhen a company elects to change to LIFO, it is usually impossible to calculate the income effect on prior years. As a result, the company does not report the change retrospectively. Instead, the LIFO method is used from the point of adoption forward.A disclosure note is needed to explain (a) thenature of the change; (b) the effect of thechange on current year’s income andearnings per share, and (c) why retrospective application was impracticable.Learning ObjectiveExplain the appropriate accountingtreatment when an inventory error isdiscovered.LO7Inventory Errors Overstatement of ending inventoryUnderstates cost of goods sold andOverstates pretax income. Understatement of ending inventoryOverstates cost of goods sold andUnderstates pretax income.Inventory ErrorsOverstatement of beginning inventoryOverstates cost of goods sold andUnderstates pretax income.Understatement of beginning inventoryUnderstates cost of goods sold andOverstates pretax income.Inventory ErrorsOverstatement of purchasesOverstates cost of goods sold andUnderstates pretax income.Understatement of purchasesUnderstates cost of goods sold andOverstates pretax income. Appendix 9PurchaseCommitmentsPurchase CommitmentsPurchase 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 2006, Matrix, Inc. signed two purchase commitments. The first requires Matrix to purchase raw materials for $100,000 byDecember 1, 2006. On December 1, 2006, the raw materialshad a market value of $90,000. The second requires Matrixto purchase inventory items for $200,000 by March 1, 2007.On December 31, 2006, the market value of the inventory itemswere $188,000. On March 1, 2007, the market value of the inventoryitems were $186,000. Matrix uses the perpetual inventory systemand is a calendar year-end company.Let’s make the journal entries for these commitments.Purchase CommitmentsSingle year commitmentMulti-year CommitmentEnd of Chapter 9