10B - Ch 9 - Inventory 1 of 2

Assume that the company applied the lower-of-cost-or-net realizable value to each inventory item. As you can see, the final inventory value is $384,000.

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purchase commitment. If the buyer enters into a ______ purchase commitments orders... 1. Such orders are subject to cancellation 2. The buyer and seller will determine prices at the time of shipment 3. This does not represent either an asset or a liability to the buyer. 4. The buyer need not record such purchase commitments or report them in the financial statements

normal

Lower of cost or net realizable value - Companies often estimate these selling costs by using a ______.

predetermined percentage

Example: Suppose the selling price of a product is $10 per unit. If the company estimates that sales commissions and shipping costs are approximately 10% of selling price, then NRV would be $____.

$9 =$10 - 10% of $10

The business later increases the price of the shirts to $24.There would be a $____ markdown cancellation.

1 =$24-$23

There are 2 methods of estimating ending inventory at cost 1. ____ and 2.____

1. Gross Profit Method aka Gross Margin Method 2. Retail Inventory Method

i. Decreases in the original sales prices. ii. These cuts in sales prices may be necessary because of a decrease in the general level of prices, special sales, soiled or damaged goods, overstocking, and market competition.

Markdown

i. Occur when the markdowns are later offset by increases in the prices of goods that the retailer had marked down i.e. after a one-day sale ii. Cannot exceed the original markdown.

Markdown cancellations

for the lower of cost or net realizable value, If the NRV greater or less than historical cost, the company does not need to do anything

NRV greater than historical cost

____ is the estimated selling price in the ordinary course of business minus reasonably predictable costs of completion, disposal, and transportation.

Net realizable value NRV

Treatment of special items: f. Abnormal shortages are deducted from ______ columns and reported as a special inventory amount or as a loss.

both the cost and retail

Treatment of special items: a. ______ costs are part of the purchase cost.

Freight

Calculate the cost-to-retail ratio

Goods Available for Sale at cost divided by Goods Available for Sale at retail = Cost-to-retail ratio aka Cost-to-retail percentage

Calculate estimated ending inventory (aka goods on hand) at retail

Goods Available for Sale at retail- Sales = Ending Inventory at retail

_____ method of estimating ending inventory relies on the historical relationship among net sales, cost of goods sold, and gross profit. Recall you learned this formula before in Principles of Accounting I and Ch. 8..

Gross Profit Method

Lower of Cost or Market (LCM) 1. Up until recently, LCM was the approach required by GAAP. Now, GAAP requires companies to use lower of cost or net realizable value LCNRV unless the company uses _____ methods.

LIFO or retail inventory

B. However, inventory may later drop in value below the original cost due to the following reasons 1. ____ 2. _____ 3. ____ 4. _____ 5. _____

1. Obsolescence 2. Damaged goods 3. Deterioration 4. Price level changes 5. Any other situation that might compromise the inventory's salability

Recording of Inventories in General A. Inventory is initially recorded at cost by using one of the historical cost based methods discussed earlier. 1. _____, 2.______ 3.______ & 4._____

1. Specific identification 2. Average cost 3. FIFO4. LIFO

After Father's Day, the company reduced the remaining shirts to a sale price of $23. At this point, an additional markup cancellation of $____ has taken place, and a $____ markdown has occurred.

2 = $32-$30 original retail price, 7 = $30 original retail price - $23

This $5 markup made the price too high for customers and sales slowed. Original selling price was $30 and the company raised to $35 on Father's day. The company then reduced the price to $32. At this point, we would say that a markup cancellation of $_____

3 = $35-$32.

Company A recently purchased 100 dress shirts. The cost was $15 per shirt. The selling price is $30 per shirt. a. The shirts were selling quickly in anticipation of Father's Day so the company raised the price to $35 per shirt. In this case, the shirts have a markup of $____

5 = $35-$30 original retail price

Contrast this to the accounting for inventory in a meat-packing plant. The raw material is just the cattle that the company purchases. A unit of cattle is then divided into many parts that are the products. To allocate the cost of the animal into the cost of ribs, chuck, and shoulders is very difficult.

Another situation in which valuation at net realizable value is allowed is when it is difficult to obtain cost figures--meat-packing plants.

Most manufacturing companies combine various raw materials and purchased parts to create a finished product (i.e. airplanes for Boeing). Many raw materials or component parts are combined to make one product. Thus, the company can use the cost basis to account for various items in inventory because it knows the cost of each individual component part.

Another situation in which valuation at net realizable value is allowed is when it is difficult to obtain cost figures--meat-packing plants.

formula for the gross profit method

Beg inventory + Purchases = cost of goods available for sale - cost of goods sold = Ending Inventory

example of ______ method by itself

Conventional

______ method- uses markups and markup cancellations in calculating the cost-to-retail ratio. It DOES NOT include markdowns and markdown cancellations in calculating the cost-to-retail ratio. 2. ____ Method- uses markups, markup cancellations, markdowns, and markdown cancellations in calculating the cost-to-retail ratio.

Conventional, Cost

C. Methods of Recording NRV Instead of Cost 1. There are 2 methods to write-down of inventory and record the income effect of valuing inventory at NRV. a. Method 1: ____method

Cost-of-goods-sold. This method debits COGS and credits Inventory.

______ a. This is the current replacement cost. the cost to replace the inventory by purchase or production, but it is constrained to a "ceiling" and "floor" to prevent companies from overstating or understating of inventory (see below)

Designated market value

The computations for In-Fusion are: Conventional method (A): ______ and Cost method (B) ____

Ending Inventory at Retail X Cost Ratio = Value of Ending Inventory. conventional method $12,500 X 53.9% = $6,737.50 cost method (B): $12,500 X 54.7% = $6,837.50

Calculate estimated ending inventory at cost

Ending Inventory at retail X Cost-to-retail ratio = Ending inventory at cost

Mander Corp. has unfinished inventory with a cost of $950, a sales value of $1,000, estimated cost of completion of $50, and other estimated selling costs of $200. How much will inventory be reported on the balance sheet? Will net income be affected?

First calculate NRV: 1,000 - 50 - 200 = $750 Since the NRV amount of $750 is < the historical cost amount of $950, it now reports inventory on its balance sheet at $750. Net income will be reduced by $200 (950 - 750) on its income statement.

valuation Using _______ A. This is used when a company buys a group of varying units in a single lump-sum purchase aka a basket purchase. B. Assume that Woodland Developers purchases land for $1 million that it will subdivide into 400 lots with varying shapes and sizes. These lots are roughly sorted into three groups graded A, B, and C. As the company sells the lots, it apportions the purchase cost of $1 million among the lots sold and the lots remaining on hand.

Relative Sales Value Method

Different Versions of the ____ Method 1. Conventional method aka the conventional retail inventory method or the lower-of-cost-or-market approach - based on lower-of-average-cost-or-market 2. Cost method aka Average Cost 3. LIFO retail method 4. Dollar-value LIFO retail method

Retail Inventory

This method is very common. Here's why...a. High-volume retailers have many different types of merchandise. It would be very difficult to determine the cost of each sale, to enter cost codes on the tickets, to change the codes to reflect declines in value of the merchandise, to allocate costs such as transportation, etc. Thus, these companies compile their inventories at retail prices.

Retail Inventory Method

______ Concepts 1. In the simplistic Best Buy example that we looked at earlier on the previous page, the amounts shown in the "Retail" column of that example represent the original retail prices without assuming price changes. However, retailers frequently mark up or mark down the prices they charge buyers. These markups and markdowns affect ending inventory valuation.

Retail-Method

____ method allows for company to approximate the ending inventory balance without a physical count. Even so, companies still make periodic inventory counts to avoid a potential overstatement of the inventory. It acts as a control device because a company will have to explain any deviations from a physical count at the end of the year. Such counts are especially important in retail companies where loss due to shoplifting or breakage is common.

The retail inventory

purchase commitment - ______ usually retains title to the merchandise or raw materials covered in the purchase commitments. Thus, the buyer does not make any journal entries to reflect commitments for purchases of goods that the seller has not shipped.

The seller

Additional comments about methods of applying LCNRV b. A company often value inventory on a total-inventory basis when it offers only one end product (comprised of many different raw materials). If it produces several end products, a company might use _____ approach instead.

a category

Calculate Goods Available for Sale at both cost and retail

a. Beg inventory at cost + Purchases at cost = Goods Available for Sale at cost / Beg inventory at retail + Purchases at retail = Goods Available for Sale at retail

the retail inventory method requires the retail company to keep a record of __________, ______, _______

a. Beginning inventory at cost and retail b. Purchases at cost and retail c. Sales for the period

Methods of Applying LCNRV 1. For financial accounting/book purposes, LCNRV can be applied to a.____ b. _____ c. _____

a. Individual inventory items (as shown in the previous example) b. Categories of inventory c. The entire inventory.

C. When the inventory drop in value happens...1. The "historical cost" principle is abandoned. 2. 2 of the following approaches are then used

a. Lower of cost or net realizable value (LCNRV) b. Lower of cost or market (LCM)

Key Definitions used in Retail Inventory Method a. ____ b. _____

a. Markup- increase in the original retail price. b. Markup cancellation

How to Calculate LCM Lower of Cost or Market 1. Find the designated market value, which is to find the middle amount between a _____ b _____ c ______

a. Replacement cost b. NRV c. NRV less a normal profit margin

3. LCM requires that inventory be reported in the financial statements at the lower of either the inventory's a. ____ or b. ____

a. historical cost OR b. designated market value

Accountants generally leave the allowance account on the books. They just adjust the balance at the next year-end to agree with the discrepancy between cost and the LCNRV at that balance sheet date. a. If prices are falling, the company records____ b. If prices are rising, the company records ____

an additional write-down. an increase in income

Methods of Applying LCNRV - For income tax purposes, the rule must be applied on _____ basis barring practical difficulties.

an individual item-by-item basis

LCM - Companies usually price inventory on _____ basis. 3. The method selected should be the one that most clearly reflects ______. 4. Once the method is selected, it should be consistently applied going forward

an item-by-item, income

examples of net realizable value - Mining companies ordinarily report inventories of certain minerals (especially rare metals) at selling prices because there is often a _____ market without significant costs of disposal. 2. Agricultural products i.e. harvested crops or animals held-for-sale that are ______ at quoted prices.

controlled market, immediately marketable

Another situation in which valuation at net realizable value is allowed is when it is difficult to obtain ____ --meat-packing plants.

cost figures

Treatment of special items: c. Purchase discounts and allowances usually are considered as a reduction of the ______.

cost of purchases

Create an adjusting journal entry for this using COGS method. COGS 108,000, Ending inventory at cost $82,000, ending inventory at NRV $70,000

debit 12,000 to COGS and credit 12,000 inventory to reduce the inventory balance - the cogs balance should be 108,000 + 12,000

Create an adjusting journal entry for this using Loss method. COGS 108,000, Ending inventory at cost $82,000, ending inventory at NRV $70,000

debit Loss on write down of inventory and credit inventory or debit Loss on Write-Down of Inventory and credit Allowance to Reduce Inventory to NRV the debit side is a regular expense account not a cogs acc

Lower of Cost or Market (LCM) 2. Like the LCNRV, LCM is used when _____ about the value of an asset. LCM was developed to avoid reporting inventory at an amount greater than the benefits it can provide.

doubt exists

Below are some of the reason why this happens... 1. It is impractical (too costly) to take physical inventory. 2. A disaster i.e. fire occurs and the amount of loss cannot be determined. 3. When inventory or inventory records get destroyed by a catastrophe i.e. fire, flood, computer virus, etc. 4. The company or auditors only need a quick estimate of the company's inventory for interim reports

examples of why Sometimes companies use alternative measures to estimate ending inventory.

If the buyer enters into a _____, purchase contract... 1. The buyer still does not recognize an asset or liability at the date of inception, because the contract is "executory" in nature—meaning neither party has fulfilled its part of the contract. 2. The buyer should disclose such contract details in a note to its financial statements if it is material. 3. Example of a purchase commitment disclosure

formal, non-cancelable

Special Items Relating to Retail Method 1. The retail inventory method becomes more complicated when we consider such items as ___, ___, ___

freight-in, purchase returns and allowances, and purchase discounts

Contracts for the purchase of raw materials in 2017 have been exeuted in the amount of $600,000. The market price of such raw materials on Dec 31, 2016 is $640,000.

if the contract price > than the market price and the buyer expects that losses will occur when the purchase is effected, the buyer should recognize losses in the period during which such declines in market prices take place.

(A) represents Conventional Method (B) represents Cost Method

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3. Example using the conventional retail inventory method

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Methods of Applying of LCM just like for LCNRV 1. Like LCNRV, LCM can be applied to a. Each inventory item directly b. Each category c. Total inventory

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Ultimately, designated market value used in LCM is the middle of these 3 amounts i. Replacement cost ii. Net Realizable Value iii. Net Realizable Value less a normal profit margin

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Use the lower of either the historical cost OR designated market value as your final inventory value. Assuming the company uses the loss method and an allowance account, it would make the following journal entry.

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debit loss Due to Decline of Inventory to Market 415,000* - 350,000= 65,000 and credit Allowance to Reduce Inventory to Market 65,000 note, 415,000 is the The sum of all inventory at cost (80,000+100,000+50,000+90,000+95,000).

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i. Price ceiling (max) Net Realizable Value (NRV) ii. Price floor (min) Net realizable value less a normal profit margin

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Additional comments about methods of applying LCNRV c. The method selected should be the one that most clearly reflects _____. d. Once a company selects a method, it should apply that method consistently from one period to another

income

LCNRV - Also, the company debits either COGS or a Loss Due to Decline of Inventory to NRV aka Loss on Write-Down of Inventory on its _______. This results in a decrease in net income. We will discuss the differences in the debits and credits later in the notes.

income statement

Additional comments about methods of applying LCNRV a. If a company follows major categories or total inventory approach in applying the LCNRV rule, ______ tend to offset decreases in ____.

increases in selling prices tend to offset decreases in selling prices.

Methods of Applying LCNRV - Companies usually value inventory on an _______ basis because it provides the most conservative valuation for balance sheet purposes.

individual item-by-item

E. Use of an Allowance—Multiple Periods 1. With respect to accounting for the allowance in the subsequent period... a. If the company still has on hand the merchandise in question, it should ______. b. If it does not keep that account, the company will overstate beginning inventory and cost of goods.

it should retain an allowance account. However, if the company has sold the goods, then it should close the account. It then establishes a "new allowance account" for any decline in inventory value that takes place in the current year

Generally, the _____ method presentation is preferable because it clearly discloses the loss resulting from a decline in inventory to NRV. Regardless of the method, there is usually also a disclosure note.

loss method

C. Methods of Recording NRV Instead of Cost Method 2: ______ method. This method debits _____ and credits _____.

loss method. debits Loss on Write-Down of Inventory (aka Loss Due to Decline of Inventory to NRV) and credits either Inventory or Allowance to Reduce Inventory to NRV which is a contra asset account to Inventory.

Companies report their inventories at the ______ at each reporting date

lower-of-cost-or-net realizable value LCNRV

i. Decreases in prices of merchandise that the retailer had marked up above the original retail price. ii. Cannot exceed the original markup.

markup cancellation

Valuation at Net Realizable Value A. A company usually records inventory at cost, LCNRV, or LCM. However, under certain circumstances, it can record inventory at _____ -- even if that amount is above cost.

net realizable value

under certain circumstances, it can record inventory at _____ - 3 of these conditions must be met 1. There is a controlled market with a quoted price applicable to all quantities. 2. No significant costs of disposal are involved. 3. The product is available for immediate delivery.

net realizable value

Usually, companies can obtain beginning inventory and purchases to calculate cost of goods available for sale. Since most companies often sell products that have similar gross profit ratios, if they know what ______ are and what percentage of net sales ____ is (aka gross profit ratio or gross profit on selling price), then they can estimate COGS. In turn, they can then calculate ending inventory.

net sales, the gross profit is

LCNRV - If the NRV is less than the historical cost, then the company reports inventory on its balance sheet at the ______. Also, the company debits either COGS or a Loss Due to Decline of Inventory to NRV.

new NRV amount by either crediting Inventory or Allowance to Reduce Inventory to NRV.

ESTIMATING ENDING INVENTORY COST - companies normally take a _____ to find out the ending inventory amount. Even if the company has a perpetual inventory system, they still take a _____ to verify the accuracy their records.

physical inventory

_______ are agreements/contracts to buy inventory (merchandise or raw materials) weeks, months, or years in advance. They obligate a company to purchase a specified amount of inventory (merchandise or raw materials) at specified prices on or before specified dates.

purchase Commitments

3. Unfortunately, there is also a disadvantage to purchase commitments. If the market price of inventory decreases before the agreement is exercised, the commitment requires the company to purchase inventory at a higher than market price and a loss on the _____ is recorded

purchase commitment

2. Companies make _____ to make sure they have sufficient stock of inventory on hand to meet customer demand and to protect against increases in purchase price.

purchase commitments

Treatment of special items: d. Transfers-in from another department are reported in the same way as ______.

purchases from an outside company

Treatment of special items: b. Purchase returns are ordinarily considered as a ______ at both cost and retail.

reduction of the price

Treatment of special items: g. Employee discounts are deducted from the ______.

retail column in the same way as sales. These discounts are not considered in the cost-to-retail ratio because they do not reflect an overall change in the selling price

Treatment of special items: e. Normal shortages i.e. breakage, damage, theft, shrinkage should reduce the ____ column because these goods are no longer available for sale. Do companies consider this amount in computing the cost-to-retail ratio?

retail column, no, companies do not consider this amt in computing the cost to retail ratio. They show normal shortages as a deduction similar to sales to arrive at ending inventory at retail.

Since a pattern between cost and retail price exists for most retailers, they can then use a formula to convert retail prices to cost. Thus, this method is called the ____ method.

retail inventory

b. The retail inventory method expedites the physical inventory count at the end of the year. The crew taking the physical inventory needs to record only the _____ of each item. The crew does not need to look up each item's invoice cost, thereby saving time and expense.

retail price

Lower of cost or net realizable value - These selling costs could include things such as ____ and _____.

sales commissions and shipping costs.

Thus, meat-packing companies sometimes carry inventories at _____ less distribution costs because it is much easier and more useful for the company to determine the market price of the various products and value them in the inventory at selling price less the various costs necessary to get them to market

sales price

GAAP does not specify which method to use for the write-down. a. If inventory write-downs are common for a company, _____ is used.

the cost of goods sold method

GAAP does not specify which method to use for the write-down. b. If the write-down is substantial and unusual, _____ method would be used.

the loss method

NRV is the net amount that a company expects to realize from the _____

the sale of inventory.

Reporting inventories at LCNRV - Results in losses being recognized in the period when _______ rather than in the period in which the inventory is eventually sold

the value of inventory declines below its cost

Reporting inventories at LCNRV - Is justified because inventories should not be reported at amounts higher than _______ from sale or use. In other words, it avoids reporting inventory at an amount greater than the benefits it can provide.

their expected realization

D. Note the reduced inventory value becomes the new cost basis going forward. Even if the inventory value later recovers prior to its sale (goes back up again), _______________.

we do not write it back up.