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