Chapter 9 - intermediate 2
What is the gross profit/margin if you have a cost of $75 and a sales price of $100
$25
Cash flow methods:
1. Approximating Average Cost 2. Approximating Average Lower of Cost or Market 3. The LIFO Retail Method
Why would a company want to estimate inventory?
1. Avoid taking a physical count every time a company wants to prepare financial statements 2. Determine the cost of inventory lost, stolen, destroyed 3. Auditors testing of overall reasonableness of inventory amounts reported by client 4. Budgeting, forecasting
Ending inventory at retail/cost will be in layers
1. Beginning Inventory 2. Current Period Layer
Compute two cost to retail ratios
1. Beginning inventory 2. Goods available for sale EXCLUDING beginning inventory
Steps to calculate the lower of cost or market (LCM)
1. Compute market 2. Compare cost with market value
Cautions against companies estimating inventory
1. Good estimate is function of gross profit ratio 2. Inventory costing assumption must be considered 3. Estimate would need to be adjusted for theft/spoilage 4. NOT GAAP- count is required
Approximating Average Lower of Cost or Market
1. Include markups in computation of available for sale 2. includes markdowns after available for sale
LCNRV can be applied to
1. Individual inventory items 2. Categories of similar items 3. Inventory as a total
Changes in circumstances that cause companies to sell below cost:
1. Inventory damage 2. Physical deterioration 3. Obsolescence (new version of iphone) 4. Changes in price levels 5. Situations that lessen demand (recession)
Advantages of the retail inventory method:
1. More accurate than gross profit method (based on current not historical relationship between cost and selling prices) 2. Allowed for financial reporting purposes 3. Accommodates different cash flow methods 4. Determine the cost of inventory lost, stolen, destroyed 5. Testing of overall reasonableness of inventory counts 6. Budgeting, forecasting 7. But physical count made to verify accuracy and detect spoilage, theft, other irregularities
The LIFO Retail Method
1. compute two cost to retail ratios 2. ending inventory at retail/ cost will be in layers
Retail terminology
1. initial markup 2. additional markup 3. markup cancellation 4. markdowns 5. markdown cancellation
3 variables in computing market:
1. replacement cost 2. ceiling- net realizable value 3. Floor-net realizable value less normal profit margin
Compare NRV to Cost
Cost <NRV no aje as cost is already lower than NRV
Adjusting entry for cost to inventory
Debit Cost of goods sold Credit Inventory
Write down depends upon which inventory costing method a company uses:
FIFO and LIFO
Compute NRV
NRV<cost- aje to reduce inventory cost to NRV which becomes the new cost and is the amount reported on the balance sheet
FIFO
average cost, any method other than LIFO or retail inventory method
markdown
decrease in selling price subsequent to initial markup
markdown cancellations
elimination of a markdown
markup cancellation
elimination of an additional markup
GAAP requires companies to evaluate ______ inventory for decline in value
end-of-period
Net realizable value
estimated selling price of the inventory in the ordinary course of business less any costs of completion, disposal, and transportation
additional markup
increase in selling price subsequent to initial markup
expected benefit - reduced net income
inventory writedown
LCM
lower of cost or market
LCNRV
lower of cost or net realizable value
Approximating average cost
markups and markdowns included in computation of available for sale
Initial markup
original amount of markup from cost to selling price
adjusting cost of expected benefit
reduce inventory and increase cost of goods sold
LIFO
retail inventory method, LCM
Lower of cost or net realizable value approach reports
the decline (loss) in the period in which the benefit occurs
If inventory subsequently recovers, do not write up the inventory:
the gross profit will incorporate the increased sales price
The retail inventory method
the ratio of cost to retail assists in converting year-end inventory at retail to cost
Compute market
which means compute three numbers and choose the middle value as market