9
Inventories: CHAPTER Additional Valuation Issues
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics 1. Lower-of-cost-or-market. 2. Inventory accounting changes; relative sales value method; net realizable value. 3. Purchase commitments. 4. Gross profit method. Questions 1, 2, 3, 4, 5, 6 7, 8 Brief Exercises 1, 2, 3 4 Exercises 1, 2, 3, 4, 5, 6 7, 8 Problems 1, 2, 3, 9, 10 Concepts for Analysis 1, 2, 3, 5
9 10, 11, 12, 13 14, 15, 16 17, 18 19
5, 6 7
9, 10 11, 12, 13, 14, 15, 16, 17 18, 19, 20, 22, 23, 26 21 22, 23 24, 25, 26, 27 28
9 4, 5
6
5. Retail inventory method. 6. Presentation and analysis. *7. LIFO retail. *8. Dollar-value LIFO retail. *9. Special LIFO problems.
8 9 10 11
6, 7, 8, 10, 11 9 12, 13, 14 11, 13 13, 14
4, 5
7
*This material is discussed in an Appendix to the chapter.
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ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives 1. 2. 3. 4. 5. Describe and apply the lower-of-cost-or-market rule. Explain when companies value inventories at net realizable value. Explain when companies use the relative sales value method to value inventories. Discuss accounting issues related to purchase commitments. Determine ending inventory by applying the gross profit method. Determine ending inventory by applying the retail inventory method. Explain how to report and analyze inventory. Determine ending inventory by applying the LIFO retail methods. Brief Exercises 1, 2, 3 1, 2, 3 4 5, 6 7 Exercises 1, 2, 3, 4, 5, 6 1, 2, 3, 4, 5, 6 7, 8 9, 10 11, 12, 13, 14, 15, 16, 17 18, 19, 20 21 22, 23, 24, 25, 26, 27, 28 9 4, 5 Problems 1, 2, 3, 9, 10 1, 2, 3, 9, 10
6. 7. *8.
8 9 10, 11
6, 7, 8 9 11, 12, 13, 14
*This material is discussed in an Appendix to the chapter.
9-2
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ASSIGNMENT CHARACTERISTICS TABLE
Level of Difficulty Simple Simple Simple Simple Moderate Simple Simple Simple Simple Simple Simple Simple Simple Moderate Simple Simple Moderate Moderate Simple Simple Simple Moderate Moderate Simple Simple Moderate Moderate Simple Simple Moderate Moderate Moderate Complex Moderate Moderate Time (minutes) 1520 1015 1520 1015 2025 1015 1520 1217 0510 1520 813 1015 1520 1520 1015 1520 2025 2025 1217 2025 1015 2535 1520 1015 510 2025 2025 1015 1015 2530 3035 2030 4045 2030 2030
Item E9-1 E9-2 E9-3 E9-4 E9-5 E9-6 E9-7 E9-8 E9-9 E9-10 E9-11 E9-12 E9-13 E9-14 E9-15 E9-16 E9-17 E9-18 E9-19 E9-20 E9-21 *E9-22 *E9-23 *E9-24 *E9-25 *E9-26 *E9-27 *E9-28 P9-1 P9-2 P9-3 P9-4 P9-5 P9-6 P9-7
Description Lower-of-cost-or-market. Lower-of-cost-or-market. Lower-of-cost-or-market. Lower-of-cost-or-market--journal entries. Lower-of-cost-or-market--valuation account. Lower-of-cost-or-market--error effect. Relative sales value method. Relative sales value method. Purchase commitments. Purchase commitments. Gross profit method. Gross profit method. Gross profit method. Gross profit method. Gross profit method. Gross profit method. Gross profit method. Retail inventory method. Retail inventory method. Retail inventory method. Analysis of inventories. Retail inventory method--conventional and LIFO. Retail inventory method--conventional and LIFO. Dollar-value LIFO retail. Dollar-value LIFO retail. Conventional retail and dollar-value LIFO retail. Dollar-value LIFO retail. Change to LIFO retail. Lower-of-cost-or-market. Lower-of-cost-or-market. Entries for lower-of-cost-or-market--cost of good sold and loss. Gross profit method. Gross profit method. Retail inventory method. Retail inventory method.
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ASSIGNMENT CHARACTERISTICS TABLE (Continued)
Level of Difficulty Moderate Moderate Moderate Moderate Moderate Moderate Complex Moderate Moderate Moderate Moderate Moderate Moderate Simple Time (minutes) 2030 3040 3040 3035 3040 3040 4050 1525 2030 1520 2530 1525 2025 1015
Item P9-8 P9-9 P9-10 *P9-11 *P9-12 *P9-13 *P9-14 CA9-1 CA9-2 CA9-3 CA9-4 CA9-5 CA9-6 *CA9-7
Description Retail inventory method. Statement and note disclosure, LCM, and purchase commitment. Lower-of-cost-or-market. Conventional and dollar-value LIFO retail. Retail, LIFO retail, and inventory shortage. Change to LIFO retail. Change to LIFO retail; dollar-value LIFO retail. Lower-of-cost-or-market. Lower-of-cost-or-market. Lower-of-cost-or-market. Retail inventory method. Cost determination, LCM, retail method. Purchase commitments. Retail inventory method and LIFO retail.
9-4
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SOLUTIONS TO CODIFICATION EXERCISES
CE9-1
(a) According to the Master Glossary, Inventory is defined as the aggregate of those items of tangible personal property that have any of the following characteristics: 1. Held for sale in the ordinary course of business 2. In process of production for such sale 3. To be currently consumed in the production of goods or services to be available for sale. The term inventory embraces goods awaiting sale (the merchandise of a trading concern and the finished goods of a manufacturer), goods in the course of production (work in process), and goods to be consumed directly or indirectly in production (raw materials and supplies). This definition of inventories excludes long-term assets subject to depreciation accounting, or goods which, when put into use, will be so classified. The fact that a depreciable asset is retired from regular use and held for sale does not indicate that the item should be classified as part of the inventory. Raw materials and supplies purchased for production may be used or consumed for the construction of long-term assets or other purposes not related to production, but the fact that inventory items representing a small portion of the total may not be absorbed ultimately in the production process does not require separate classification. By trade practice, operating materials and supplies of certain types of entities such as oil producers are usually treated as inventory. (b) According to the Master Glossary, the phrase lower-of-cost-or-market, the term market means current replacement cost (by purchase or by reproduction, as the case may be) provided that it meets both of the following conditions. 1. Market shall not exceed the net realizable value 2. Market shall not be less than net realizable value reduced by an allowance for an approximately normal profit margin. According to the Master Glossary, two definitions are provided for the phrase Net Realizable Value 1. Estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal. 2. Valuation of inventories at estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.
(c)
The second definition provides a link to guidance for lower-of-cost-or-market in the agricultural industry (FASB ASC 905-330-35) Growing Crops 35-1 Costs of growing crops shall be accumulated until the time of harvest. Growing crops shall be reported at the lower-of-cost-or-market.
> Developing Animals 35-2 Developing animals to be held for sale shall be valued at the lower-of-cost-or-market.
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CE9-1 (Continued)
> Animals Available and Held for Sale 35-3 Animals held for sale shall be valued at either of the following: (a) The lower-of-cost-or-market (b) At sales price less estimated costs of disposal, if all the following conditions exist: 1. The product has a reliable, readily determinable, and realizable market price. 2. The product has relatively insignificant and predictable costs of disposal. 3. The product is available for immediate delivery. Inventories of harvested crops and livestock held for sale and commonly referred to as valued at market are actually valued at net realizable value. > Harvested Crops 35-4 Inventories of harvested crops shall be valued using the same criteria as animals held for sale in the preceding paragraph.
CE9-2
According to FASB ASC 330-10-35-1 through 5: Adjustments to Lower-of-Cost-or-Market A departure from the cost basis of pricing the inventory is required when the utility of the goods is no longer as great as their cost. Where there is evidence that the utility of goods, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the difference shall be recognized as a loss of the current period. This is generally accomplished by stating such goods at a lower level commonly designated as market. Thus, in accounting for inventories, a loss shall be recognized whenever the utility of goods is impaired by damage, deterioration, obsolescence, changes in price levels, or other causes. The measurement of such losses shall be accomplished by applying the rule of pricing inventories at the lower-of-cost-or-market. This provides a practical means of measuring utility and thereby determining the amount of the loss to be recognized and accounted for in the current period. However, utility is indicated primarily by the current cost of replacement of the goods as they would be obtained by purchase or reproduction. In applying the rule, however, judgment must always be exercised and no loss shall be recognized unless the evidence indicates clearly that a loss has been sustained. Replacement or reproduction prices would not be appropriate as a measure of utility when the estimated sales value, reduced by the costs of completion and disposal, is lower, in which case the realizable value so determined more appropriately measures utility. In addition, when the evidence indicates that cost will be recovered with an approximately normal profit upon sale in the ordinary course of business, no loss shall be recognized even though replacement or reproduction costs are lower. This might be true, for example, in the case of production under firm sales contracts at fixed prices, or when a reasonable volume of future orders is assured at stable selling prices. In summary, the determination of the amount of the write-off should be based on factors that relate to the net realizable value of the inventory, not the amount that will maximize the loss in the current period. Note that the sale manager's proposed accounting is an example of "cookie jar" reserves, as discussed in Chapter 4. By writing the inventory down to an unsupported low value, the company can report higher gross profit and net income in subsequent periods when the inventory is sold.
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CE9-3
According to FASB ASC 330-10-35-6, if inventory has been the hedged item in a fair value hedge, the inventory's cost basis used in the lower-of-cost-or-market accounting shall reflect the effect of the adjustments of its carrying amount made pursuant to paragraph 815-25-35-1(b). And, according to 8152-35-1(b), gains and losses on a qualifying fair value hedge shall be accounted for as follows: The gain or loss (that is, the change in fair value) on the hedged item attributable to the hedged risk shall adjust the carrying amount of the hedged item and be recognized currently in earnings.
CE9-4
See FASB ASC 210-10-S99--Regulation S-X Rule 5-02, Balance Sheets S99-1 The following is the text of Regulation S-X Rule 5-02, Balance Sheets. The purpose of this rule is to indicate the various line items and certain additional disclosures which, if applicable, and except as otherwise permitted by the Commission, should appear on the face of the balance sheets or related notes filed for the persons to whom this article pertains (see 210.401(a)). ASSETS AND OTHER DEBITS Current Assets, when appropriate [See 210.405] 6. Inventories. (a) State separately in the balance sheet or in a note thereto, if practicable, the amounts of major classes of inventory such as: 1. Finished goods; 2. inventoried cost relating to long-term contracts or programs (see (d) below and 210.405); 3. work in process (see 210.405); 4. raw materials; and 5. supplies. If the method of calculating a LIFO inventory does not allow for the practical determination of amounts assigned to major classes of inventory, the amounts of those classes may be stated under cost flow assumptions other that LIFO with the excess of such total amount over the aggregate LIFO amount shown as a deduction to arrive at the amount of the LIFO inventory. (b) The basis of determining the amounts shall be stated. If cost is used to determine any portion of the inventory amounts, the description of this method shall include the nature of the cost elements included in inventory. Elements of cost include, among other items, retained costs representing the excess of manufacturing or production costs over the amounts charged to cost of sales or delivered or in-process units, initial tooling or other deferred startup costs, or general and administrative costs. The method by which amounts are removed from inventory (e.g., average cost, first-in, firstout, last-in, first-out, estimated average cost per unit) shall be described. If the estimated average cost per unit is used as a basis to determine amounts removed from inventory under a total program or similar basis of accounting, the principal assumptions (including, where meaningful, the aggregate number of units expected to be delivered under the program, the number of units delivered to date and the number of units on order) shall be disclosed.
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CE9-4 (Continued)
If any general and administrative costs are charged to inventory, state in a note to the financial statements the aggregate amount of the general and administrative costs incurred in each period and the actual or estimated amount remaining in inventory at the date of each balance sheet. (c) If the LIFO inventory method is used, the excess of replacement or current cost over stated LIFO value shall, if material, be stated parenthetically or in a note to the financial statements.
(d) For purposes of 210.502.3 and 210.502.6, long-term contracts or programs include 1. all contracts or programs for which gross profits are recognized on a percentageof-completion method of accounting or any variant thereof (e.g., delivered unit, cost to cost, physical completion), and 2. any contracts or programs accounted for on a completed contract basis of accounting where, in either case, the contracts or programs have associated with them material amounts of inventories or unbilled receivables and where such contracts or programs have been or are expected to be performed over a period of more than twelve months. Contracts or programs of shorter duration may also be included, if deemed appropriate. For all long-term contracts or programs, the following information, if applicable, shall be stated in a note to the financial statements: (i) The aggregate amount of manufacturing or production costs and any related deferred costs (e.g., initial tooling costs) which exceeds the aggregate estimated cost of all inprocess and delivered units on the basis of the estimated average cost of all units expected to be produced under long-term contracts and programs not yet complete, as well as that portion of such amount which would not be absorbed in cost of sales on existing firm orders at the latest balance sheet date. In addition, if practicable, disclose the amount of deferred costs by type of cost (e.g., initial tooling, deferred production, etc.) (ii) The aggregate amount representing claims or other similar items subject to uncertainty concerning their determination or ultimate realization, and include a description of the nature and status of the principal items comprising such aggregate amount. (iii) The amount of progress payments netted against inventory at the date of the balance sheet.
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ANSWERS TO QUESTIONS
1. Where there is evidence that the utility of goods to be disposed of in the ordinary course of business will be less than cost, the difference should be recognized as a loss in the current period, and the inventory should be stated at market value in the financial statements. 2. The upper (ceiling) and lower (floor) limits for the value of the inventory are intended to prevent the inventory from being reported at an amount in excess of the net realizable value or at an amount less than the net realizable value less a normal profit margin. The maximum limitation, not to exceed the net realizable value (ceiling) covers obsolete, damaged, or shopworn material and prevents overstatement of inventories and understatement of the loss in the current period. The minimum limitation deters understatement of inventory and overstatement of the loss in the current period. 3. The usual basis for carrying forward the inventory to the next period is cost. Departure from cost is required when the utility of the goods included in the inventory is less than their cost. This loss in utility should be recognized as a loss of the current period, the period in which it occurred. Furthermore, the subsequent period should be charged for goods at an amount that measures their expected contribution to that period. In other words, the subsequent period should be charged for inventory at prices no higher than those which would have been paid if the inventory had been obtained at the beginning of that period. (Historically, the lower-of-cost-or-market rule arose from the accounting convention of providing for all losses and anticipating no profits.) In accordance with the foregoing reasoning, the rule of "cost or market, whichever is lower" may be applied to each item in the inventory, to the total of the components of each major category, or to the total of the inventory, whichever most clearly reflects operations. The rule is usually applied to each item, but if individual inventory items enter into the same category or categories of finished product, alternative procedures are suitable. The arguments against the use of the lower-of-cost-or-market method of valuing inventories include the following: (a) The method requires the reporting of estimated losses (all or a portion of the excess of actual cost over replacement cost) as definite income charges even though the losses have not been sustained to date and may never be sustained. Under a consistent criterion of realization a drop in replacement cost below original cost is no more a sustained loss than a rise above cost is a realized gain. (b) A price shrinkage is brought into the income statement before the loss has been sustained through sale. Furthermore, if the charge for the inventory write-downs is not made to a special loss account, the cost figure for goods actually sold is inflated by the amount of the estimated shrinkage in price of the unsold goods. The title "Cost of Goods Sold" therefore becomes a misnomer. (c) The method is inconsistent in application in a given year because it recognizes the propriety of implied price reductions but gives no recognition in the accounts or financial statements to the effect of the price increases. (d) The method is also inconsistent in application in one year as opposed to another because the inventory of a company may be valued at cost in one year and at market in the next year. (e) The lower-of-cost-or-market method values the inventory in the balance sheet conservatively. Its effect on the income statement, however, may be the opposite. Although the income statement for the year in which the unsustained loss is taken is stated conservatively, the net income on the income statement of the subsequent period may be distorted if the expected reductions in sales prices do not materialize.
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Questions Chapter 9 (Continued) (f) In the application of the lower-of-cost-or-market rule a prospective "normal profit" is used in determining inventory values in certain cases. Since "normal profit" is an estimated figure based upon past experiences (and might not be attained in the future), it is not objective in nature and presents an opportunity for manipulation of the results of operations.
4. The lower-of-cost-or-market rule may be applied directly to each item or to the total of the inventory (or in some cases, to the total of the components of each major category). The method should be the one that most clearly reflects income. The most common practice is to price the inventory on an item-by-item basis. Companies favor the individual item approach because tax requirements require that an individual item basis be used unless it involves practical difficulties. In addition, the individual item approach gives the most conservative valuation for balance sheet purposes. 5. (1) (2) (3) (4) (5) $14.50. $16.10. $13.75. $9.70. $15.90.
6. One approach is to record the inventory at cost and then reduce it to market, thereby reflecting a loss in the current period (often referred to as the loss method). The loss would then be shown as a separate item in the income statement and the cost of goods sold for the year would not be distorted by its inclusion. An objection to this method of valuation is that an inconsistency is created between the income statement and balance sheet. In attempting to meet this inconsistency some have advocated the use of a special account to receive the credit for such an inventory write-down, such as Allowance to Reduce Inventory to Market which is a contra account against inventory on the balance sheet. It should be noted that the disposition of this account presents problems to accountants. Another approach is merely to substitute market for cost when pricing the new inventory (often referred to as the cost-of-goods-sold method). Such a procedure increases cost of goods sold by the amount of the loss and fails to reflect this loss separately. For this reason, many theoretical objections can be raised against this procedure. 7. An exception to the normal recognition rule occurs where (1) there is a controlled market with a quoted price applicable to specific commodities and (2) no significant costs of disposal are involved. Certain agricultural products and precious metals which are immediately marketable at quoted prices are often valued at net realizable value (market price). 8. Relative sales value is an appropriate basis for pricing inventory when a group of varying units is purchased at a single lump-sum price (basket purchase). The purchase price must be allocated in some manner or on some basis among the various units. When the units vary in size, character, and attractiveness, the basis for allocation must reflect both quantitative and qualitative aspects. A suitable basis then is the relative sales value of the units that comprise the inventory. 9. The drop in the market price of the commitment should be charged to operations in the current year if it is material in amount. The following entry would be made [($6.20 $5.90) X 150,000] = $45,000: Unrealized Holding Gain or Loss--Income (Purchase Commitments)............ Estimated Liability on Purchase Commitments....................................... 45,000 45,000
The entry is made because a loss in utility has occurred during the period in which the market decline took place. The account credited in the above entry should be included among the current liabilities on the balance sheet with an appropriate note indicating the nature and extent of the commitment. This liability indicates the minimum obligation on the commitment contract at the present time--the amount that would have to be forfeited in case of breach of contract.
9-10
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Questions Chapter 9 (Continued) 10. The major uses of the gross profit method are: (1) it provides an approximation of the ending inventory which the auditor might use for testing validity of physical inventory count; (2) it means that a physical count need not be taken every month or quarter; and (3) it helps in determining damages caused by casualty when inventory cannot be counted. 11. Gross profit as a percentage of sales indicates that the margin is based on selling price rather than cost; for this reason the gross profit as a percentage of selling price will always be lower than if based on cost. Conversions are as follows: 25% on cost = 33 1/3% on cost = 33 1/3% on selling price = 60% on selling price = 20% on selling price 25% on selling price 50% on cost 150% on cost
12. A markup of 25% on cost equals a 20% markup on selling price; therefore, gross profit equals $1,000,000 ($5 million X 20%) and net income equals $250,000 [$1,000,000 (15% X $5 million)]. The following formula was used to compute the 20% markup on selling price: Gross profit on selling price = Percentage markup on cost .25 = = 20% 100% + Percentage markup on cost 1 + .25 $ 400,000 $1,140,000 60,000 1,950,000 780,000 1,170,000 $ 430,000 1,200,000 1,600,000
13. Inventory, January 1, 2012.................................................................................. Purchases to February 10, 2012........................................................................ Freight-in to February 10, 2012.......................................................................... Merchandise available................................................................................. Sales to February 10, 2012................................................................................. Less gross profit at 40% ............................................................................. Sales at cost ............................................................................................. Inventory (approximately) at February 10, 2012 .....................
14. The validity of the retail inventory method is dependent upon (1) the composition of the inventory remaining approximately the same at the end of the period as it was during the period, and (2) there being approximately the same rate of markup at the end of the year as was used throughout the period. The retail method, though ordinarily applied on a departmental basis, may be appropriate for the business as a unit if the above conditions are met. 15. The conventional retail method is a statistical procedure based on averages whereby inventory figures at retail are reduced to an inventory valuation figure by multiplying the retail figures by a percentage which is the complement of the markup percent. To determine the markup percent, original markups and additional net markups are related to the original cost. The complement of the markup percent so determined is then applied to the inventory at retail after the latter has been reduced by net markdowns, thus in effect achieving a lower-ofcost-or-market valuation. An example of reduction to market follows: Assume purchase of 100 items at $1 each, marked to sell at $1.50 each, at which price 80 were sold. The remaining 20 are marked down to $1.15 each. The inventory at $15.33 is $4.67 below original cost and is valued at an amount which will produce the "normal" 33 1/3% gross profit if sold at the present retail price of $23.00.
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Questions Chapter 9 (Continued) Computation of Inventory Cost Purchases Sales Markdowns (20 X $.35) Inventory at retail Inventory at lower-of-cost-or-market $23 X 66 2/3% = $15.33 16. (a) Ending inventory: Cost Beginning inventory ...................................................................... Purchases....................................................................................... Freight-in......................................................................................... Totals ..................................................................................... Add net markups ........................................................................... Deduct net markdowns ................................................................ Deduct sales................................................................................... Ending inventory, at retail ............................................................ Ratio of cost to selling price $1,619,000 $2,535,500 = 64%. $ 149,000 1,400,000 70,000 1,619,000 _________ $1,619,000 $ Retail 283,500 2,160,000 $100 Retail $150 (120) (7) $ 23 Ratio 66 2/3%
2,443,500 92,000 2,535,500 48,000 2,487,500 2,175,000 $ 312,500
Ending inventory estimated at cost = 64% X $312,500 = $200,000. (b) The retail method, above, showed an ending inventory at retail of $312,500; therefore, merchandise not accounted for amounts to $17,500 ($312,500 $295,000) at retail and $11,200 ($17,500 X .64) at cost.
17. Information relative to the composition of the inventory (i.e., raw material, work-in-process, and finished goods); the inventory financing where significant or unusual (transactions with related parties, product financing arrangements, firm purchase commitments, involuntary liquidations of LIFO inventories, pledging inventories as collateral); and the inventory costing methods employed (lower-of-cost-or-market, FIFO, LIFO, average cost) should be disclosed. If Deere Company uses LIFO, it should also report the LIFO reserve. 18. Inventory turnover measures how quickly inventory is sold. Generally, the higher the inventory turnover, the better the enterprise is performing. The more times the inventory turns over, the smaller the net margin can be to earn an appropriate total profit and return on assets. For example, a company can price its goods lower if it has a high inventory turnover. A company with a low profit margin, such as 2%, can earn as much as a company with a high net profit margin, such as 40%, if its inventory turnover is often enough. To illustrate, a grocery store with a 2% profit margin can earn as much as a jewelry store with a 40% profit margin and an inventory turnover of 1 if its turnover is more than 20 times. 19. Two major modifications are necessary. First, the beginning inventory should be excluded from the numerator and denominator of the cost-to-retail percentage and second, markdowns should be included in the denominator of the cost-to-retail percentage.
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SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 9-1 (a) Ceiling Floor $106.00 $51.00 $193.00 ($212 $19) $161.00 ($212 $19 $32)
(b) (c)
BRIEF EXERCISE 9-2 Designated Market $2,050 4,950 4,550 3,070
Item Jokers Penguins Riddlers Scarecrows
Cost $2,000 5,000 4,400 3,200
LCM $2,000 4,950 4,400 3,070
BRIEF EXERCISE 9-3 (a) Cost-of-goods-sold method Cost of Goods Sold........................................................... Inventory .................................................................... Loss method Loss Due to Market Decline of Inventory .................. Allowance to Reduce Inventory to Market......
21,000 21,000
(b)
21,000 21,000
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9-13
BRIEF EXERCISE 9-4
Number of CDs 100 800 100 Sales Price per CD $ 5 $10 $15 Total Sales Price 500 8,000 1,500 $10,000 $ Relative Sales Price Total Cost Cost Allocated to CDs $ 400 6,400 1,200 $8,000 Cost per CD $ 4** $ 8 $12
Group 1 2 3
5/100* X $8,000 = 80/100 X $8,000 = 15/100 X $8,000 =
*$500/$10,000 = 5/100
**$400/100 = $4
BRIEF EXERCISE 9-5 Unrealized Holding Loss--Income (Purchase Commitments) ..................................................................... Estimated Liability on Purchase Commitments............................................................
50,000 50,000
BRIEF EXERCISE 9-6 Purchases (Inventory) .......................................................... Estimated Liability on Purchase Commitments .......... Cash................................................................................. 950,000 50,000 1,000,000
BRIEF EXERCISE 9-7 Beginning inventory.............................................................. Purchases................................................................................. Cost of goods available ....................................................... Sales revenue.......................................................................... Less gross profit (35% X 700,000).................................... Estimated cost of goods sold............................................ Estimated ending inventory destroyed in fire.............. $150,000 500,000 650,000 $700,000 245,000 455,000 $195,000
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BRIEF EXERCISE 9-8 Cost $ 12,000 120,000 $132,000 Retail $ 20,000 170,000 10,000 200,000 7,000 147,000 $ 46,000
Beginning inventory .................................................... Net purchases................................................................ Net markups ................................................................... Totals................................................................................ Deduct: Net markdowns ............................................................. Sales revenue ................................................................ Ending inventory at retail .......................................... Cost-to-retail ratio: $132,000 $200,000 = 66%
Ending inventory at lower-of cost-or-market (66% X $46,000) = $30,360
BRIEF EXERCISE 9-9 Inventory turnover: $304,657 $33,160 + $34,511 2 = 9.00 times
Average days to sell inventory: 365 9.00 = 40.6 days
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*BRIEF EXERCISE 9-10 Cost $ 12,000 120,000 Retail $ 20,000 170,000 10,000 (7,000) 173,000 193,000 147,000 $ 46,000
Beginning inventory....................................................... Net purchases .................................................................. Net markups ..................................................................... Net markdowns................................................................ Total (excluding beginning inventory)..................... Total (including beginning inventory)...................... Deduct: Sales revenue ................................................. Ending inventory at retail............................................. Cost-to-retail ratio: $120,000 $173,000 = 69.4% Ending inventory at cost $20,000 X 60% ($12,000/$20,000) = $12,000 26,000 X 69.4% = 18,044 $46,000 $30,044
120,000 $132,000
*BRIEF EXERCISE 9-11 Cost Beginning inventory....................................................... $ 12,000 Net purchases .................................................................. 120,000 Net markups ..................................................................... Net markdowns................................................................ Total (excluding beginning inventory)..................... 120,000 Total (including beginning inventory)...................... $132,000 Deduct: Sales revenue ................................................. Ending inventory at retail............................................. Retail $ 20,000 170,000 10,000 (7,000) 173,000 193,000 147,000 $ 46,000
9-16
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*BRIEF EXERCISE 9-11 (Continued) Cost-to-retail ratio: $120,000 $173,000 = 69.4% Ending inventory at retail deflated to base year prices $46,000 1.15 = $40,000 Ending inventory at cost $20,000 X 100% X 60% = $12,000 20,000 X 115% X 69.4% = 15,962 $27,962
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9-17
SOLUTIONS TO EXERCISES
EXERCISE 9-1 (1520 minutes) Per Unit Part No. 110 111 112 113 120 121 122 Totals (a) (b) Quantity 600 1,000 500 200 400 1,600 300 Cost $ 95 60 80 170 205 16 240 Market $100.00 52.00 76.00 180.00 208.00 0.50 235.00 Total Cost $ 57,000 60,000 40,000 34,000 82,000 25,600 72,000 $370,600 Total Market $ 60,000 52,000 38,000 36,000 83,200 800 70,500 $340,500 Lower-ofCost-orMarket $ 57,000 52,000 38,000 34,000 82,000 800 70,500 $334,300
$334,300. $340,500.
EXERCISE 9-2 (1015 minutes) Net Realizable Value Less Normal Profit (Floor) $70** 60 40 35 60 40
Item D E F G H I
Net Realizable Value (Ceiling) $90* 80 60 55 80 60
Replacement Cost $120 72 70 30 70 30
Designated Market $90 72 60 35 70 40
Cost $75 80 80 80 50 36
LCM $75 72 60 35 50 36
*Estimated selling price Estimated selling expense = $120 $30 = $90. **Net realizable value Normal profit margin = $90 $20 = $70.
9-18
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EXERCISE 9-3 (1520 minutes)
Net Real. Value Net Less Designated Replacement Realizable Normal Market Cost Value Profit Value $3.00 2.30 3.70 3.10 2.00 2.70 1.60 5.20 $4.15* 2.90 4.60 2.75 2.45 3.50 1.75 5.50 $2.90** 2.40 3.60 1.85 1.85 3.00 1.25 4.50 $3.00 2.40 3.70 2.75 2.00 3.00 1.60 5.20
Item No. 1320 1333 1426 1437 1510 1522 1573 1626
Cost per Unit $3.20 2.70 4.50 3.60 2.25 3.00 1.80 4.70
LCM $3.00 2.40 3.70 2.75 2.00 3.00 1.60 4.70
Quantity 1,200 900 800 1,000 700 500 3,000 1,000
Final Inventory Value $ 3,600 2,160 2,960 2,750 1,400 1,500 4,800 4,700*** $23,870
*$4.50 $.35 = $4.15. **$4.15 $1.25 = $2.90. ***Cost is used because it is lower than designated market value. EXERCISE 9-4 (1015 minutes) (a) 12/31/12 Cost of Goods Sold .................................... Inventory.............................................. Cost of Goods Sold .................................... Inventory.............................................. Loss Due to Market Decline of Inventory..................................................... Allowance to Reduce Inventory to Market .......................................... Allowance to Reduce Inventory to Market ..................................................... Loss Due to Market Decline of Inventory .......................................... 24,000 24,000 20,000 20,000
12/31/13
(b)
12/31/12
24,000 24,000
12/31/13
4,000* 4,000
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EXERCISE 9-4 (Continued) *Cost of inventory at 12/31/12............................................ Lower-of-cost-or-market at 12/31/12 ............................. Allowance amount needed to reduce inventory to market (a)....................................................................... Cost of inventory at 12/31/13 ........................................... Lower-of-cost-or-market at 12/31/13 ............................. Allowance amount needed to reduce inventory to market (b)....................................................................... Recovery of previously recognized loss $346,000 (322,000) $ 24,000 $410,000 (390,000) $ 20,000
= (a) (b) = $24,000 $20,000 = $4,000.
(c)
Both methods of recording lower-of-cost-or-market adjustments have the same effect on net income.
EXERCISE 9-5 (2025 minutes) (a) Sales Cost of goods sold Inventory, beginning Purchases Cost of goods available Inventory, ending Cost of goods sold Gross profit Gain (loss) due to market fluctuations of inventory* February $29,000 15,000 17,000 32,000 15,100 16,900 12,100 (2,000) $10,100 March $35,000 15,100 24,000 39,100 17,000 22,100 12,900 1,100 $14,000 April $40,000 17,000 26,500 43,500 14,000 29,500 10,500 700 $11,200
9-20
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EXERCISE 9-5 (Continued)
* Inventory at cost Inventory at the lower-of-costor-market Allowance amount needed to reduce inventory to market Gain (loss) due to market fluctuations of inventory** **$500 $2,500 = $(2,000) $2,500 $1,400 = $1,100 $1,400 $700 = $700 Jan. 31 $15,000 14,500 $ 500 Feb. 28 $15,100 12,600 $ 2,500 $ (2,000) Mar. 31 $17,000 15,600 $ 1,400 $ 1,100 $ $ Apr. 30 $14,000 13,300 700 700
(b)
Jan. 31
Loss Due to Market Decline of Inventory ....... Allowance to Reduce Inventory to Market ..................................................... Loss Due to Market Decline of Inventory ....... Allowance to Reduce Inventory to Market ..................................................... Allowance to Reduce Inventory to Market........ Recovery of Loss Due to Market Decline of Inventory ................................ Allowance to Reduce Inventory to Market........ Recovery of Loss Due to Market Decline of Inventory ................................
500 500 2,000 2,000 1,100 1,100 700 700
Feb. 28
Mar. 31
Apr. 30
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EXERCISE 9-6 Net realizable value (ceiling) Net realizable value less normal profit (floor) Replacement cost Designated market Cost Lower-of-cost-or-market $50 $14 = $36 $36 $ 9 = $27 $38 $36 Ceiling $40 $36
$38 figure used $36 correct value per unit = $2 per unit. $2 X 1,000 units = $2,000. If ending inventory is overstated, net income will be overstated. If beginning inventory is overstated, net income will be understated. Therefore, net income for 2012 was overstated by $2,000 and net income for 2013 was understated by $2,000.
9-22
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Cost Per Lot (Cost Allocated/ No. of Lots) $2,040 2,720 1,360
Group 1 4,000 2,000 $125,000 $78,000 53,040 24,960 18,200 $ 6,760 38,000 $38,000/$125,000 X 85,000 60,000 $60,000/$125,000 X 85,000 40,800 25,840 $85,000
No. of Lots 9
Sales Price Per Lot $3,000
Total Sales Price $ 27,000 Total Relative Sales Price Cost $27,000/$125,000 X $85,000
Cost Allocated to Lots $18,360
Group 2
15
Copyright 2011 John Wiley & Sons, Inc.
Group 3
19
Sales (see schedule)
EXERCISE 9-7 (1520 minutes)
Cost of goods sold (see schedule)
Gross profit
Operating expenses
Net income
Kieso, Intermediate Accounting, 14/e, Solutions Manual
Number Cost of Lots Per Sold* Lot Group 1 4 $2,040 Sales $12,000 32,000 34,000 $78,000 2,720 1,360 $53,040 23,120 21,760
Cost of Lots Sold $ 8,160
Gross Profit $ 3,840 10,240 10,880 $24,960
Group 2
8
Group 3
17
Total
29
(For Instructor Use Only)
* 95=4
15 7 = 8
19 2 = 17
9-23
9-24
Chairs 400 $54 48 30 300 800 50 $100,000 $60,000 40,000 $40,000/$100,000 X 24,000 60,000 80 24,000 $24,000/$100,000 X 60,000 14,400 $90 $36,000 $36,000/$100,000 X $60,000 $21,600
No. of Chairs Relative Sales Price
Sales Price per Chain Total Cost Cost per Chair
Total Sales Price
Cost Allocated to Chairs
Lounge chairs
Armchairs
EXERCISE 9-8 (1217 minutes)
Copyright 2011 John Wiley & Sons, Inc.
Straight chairs
Chairs Sales $18,000 8,000 6,000 $32,000 $ 7,200 3,200 2,400 $12,800 200 $54 48 30 $19,200 3,600 4,800 $10,800 100 120
Number of Chairs Sold Gross Profit
Cost per Chair
Cost of Chairs Sold
Lounge chairs
Armchairs
Straight chairs
Inventory of straight chairs
Kieso, Intermediate Accounting, 14/e, Solutions Manual
(800 120) X $30 = $20,400
(For Instructor Use Only)
EXERCISE 9-9 (510 minutes) Unrealized Holding Gain or Loss--Income (Purchase Commitments)........................................................ Estimated Liability on Purchase Commitments .................................................................... EXERCISE 9-10 (1520 minutes) (a) If the commitment is material in amount, there should be a footnote in the balance sheet stating the nature and extent of the commitment. The footnote may also disclose the market price of the materials. The excess of market price over contracted price is a gain contingency which cannot be recognized in the accounts until it is realized. The drop in the market price of the commitment should be charged to operations in the current year if it is material in amount. The following entry would be made: Unrealized Holding Gain or Loss--Income (Purchase Commitments) ............................................. Estimated Liability on Purchase Commitments .........................................................
25,000 25,000
(b)
12,000 12,000
The entry is made because a loss in utility has occurred during the period in which the market decline took place. The account credited in the above entry should be included among the current liabilities on the balance sheet, with an appropriate footnote indicating the nature and extent of the commitment. This liability indicates the minimum obligation on the commitment contract at the present time--the amount that would have to be forfeited in case of breach of contract. (c) Assuming the $12,000 market decline entry was made on December 31, 2013, as indicated in (b), the entry when the materials are received in January 2014 would be: Inventory ................................................................................ 108,000 Estimated Liability on Purchase Commitments........ 12,000 Accounts Payable.....................................................
120,000
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EXERCISE 9-10 (Continued) This entry debits the raw materials at the actual cost ($108,000), eliminates the $12,000 liability set up at December 31, 2013, and records the contractual liability for the purchase. This permits operations to be charged this year with the $108,000, the other $12,000 of the cost having been charged to operations in 2013. EXERCISE 9-11 (813 minutes) (1) 20% 100% + 20% 25% 100% + 25% = 16.67% OR 16 2/3%.
(2)
= 20%.
(3) (4)
33 1/3% = 25%. 100% + 33 1/3% 50% 100% + 50% = 33.33% OR 33 1/3%.
EXERCISE 9-12 (1015 minutes) (a) Inventory, May 1 (at cost).......................................... Purchases (at cost) ..................................................... Purchase discounts .................................................... Freight-in ........................................................................ Goods available (at cost)................................ Sales (at selling price)................................................ Sales returns (at selling price) ................................ Net sales (at selling price) ........................................ Less: Gross profit (25% of $930,000) ................... Sales (at cost)..................................................... Approximate inventory, May 31 (at cost) ............................................ $160,000 640,000 (12,000) 30,000 818,000 $1,000,000 (70,000) 930,000 232,500 697,500 $120,500
9-26
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EXERCISE 9-12 (Continued) (b) Gross profit as a percent of sales must be computed: 25% = 20% of sales. 100% + 25% Inventory, May 1 (at cost) ....................................... Purchases (at cost)................................................... Purchase discounts.................................................. Freight-in ...................................................................... Goods available (at cost) ............................. Sales (at selling price) ............................................. Sales returns (at selling price).............................. Net sales (at selling price) ...................................... Less: Gross profit (20% of $930,000)................. Sales (at cost) .................................................. Approximate inventory, May 31 (at cost).......................................... $160,000 640,000 (12,000) 30,000 818,000 $1,000,000 (70,000) 930,000 186,000 744,000 $ 74,000
EXERCISE 9-13 (1520 minutes) (a) Merchandise on hand, January 1......................... Purchases .................................................................... Less: Purchase returns and allowances .......... Freight-in ...................................................................... Total merchandise available (at cost)...... Cost of goods sold* .................................................. Ending inventory ....................................................... Less: Undamaged goods....................................... Estimated fire loss .................................................... *Gross profit = 33 1/3% = 25% of sales. 100% + 33 1/3% $ 38,000 92,000 (2,400) 3,400 131,000 90,000 41,000 10,900 $ 30,100
Cost of goods sold = 75% of sales of $120,000 = $90,000.
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EXERCISE 9-13 (Continued) (b) Cost of goods sold = 66 2/3% of sales of $120,000 = $80,000 Total merchandise available (at cost) ..................... [$131,000 [as computed in (a)] $80,000] Less: Undamaged goods ............................................ Estimated fire loss..........................................................
$51,000 10,900 $40,100
EXERCISE 9-14 Beginning inventory.................................................................. Purchases..................................................................................... $170,000 450,000 620,000 (30,000) 590,000
Purchase returns ....................................................................... Goods available (at cost)......................................................... Sales............................................................................................... $650,000 Sales returns ............................................................................... (24,000) Net sales ....................................................................................... 626,000 Less: Gross profit (30% X $626,000) .................................. (187,800) 438,200 Estimated ending inventory (unadjusted for damage) ..................................................................................... 151,800 Less: Goods on hand--undamaged (at cost) $21,000 X (1 30%) ...................................................... (14,700) Less: Goods on hand--damaged (at net realizable value) ............................................................ (5,300) Fire loss on inventory............................................................... $131,800
9-28
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EXERCISE 9-15 (1015 minutes) Beginning inventory (at cost)........................................... Purchases (at cost).............................................................. Goods available (at cost) ........................................ Sales (at selling price) ........................................................ Less sales returns................................................................ Net sales.................................................................................. Less: Gross profit* (20% of $112,000) .......................... Net sales (at cost)...................................................... Estimated inventory (at cost) ........................................... Less: Goods on hand ($30,500 $6,000)...................... Claim against insurance company ................................. *Computation of gross profit: $ 38,000 90,000 128,000 $116,000 4,000 112,000 22,400 89,600 38,400 24,500 $ 13,900
25% = 20% of selling price 100% + 25%
Note: Depending on details of the consignment agreement and Garnett's insurance policy, the consigned goods might be covered by Garnett's insurance policy.
EXERCISE 9-16 (1520 minutes) Lumber $ 250,000 1,500,000 1,750,000 1,640,000 $ 110,000 Millwork $ 90,000 375,000 465,000 410,000 $ 55,000 Hardware $ 45,000 160,000 205,000 175,000 $ 30,000
Inventory 1/1/13 (cost) Purchases to 8/18/13 (cost) Cost of goods available Deduct cost of goods sold* Inventory 8/18/13
*(See computations on next page)
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EXERCISE 9-16 (Continued) *Computation for cost of goods sold: Lumber: $2,050,000 = $1,640,000 1.25 $533,000 1.30 $245,000 1.40 = $410,000
Millwork:
Hardware:
= $175,000
*Alternative computation for cost of goods sold: Markup on selling price: Lumber: 25% = 20% or 1/5 100% + 25% 30% = 3/13 100% + 30% 40% = 2/7 100% + 40% Cost of goods sold: $2,050,000 X 80% = $1,640,000
Millwork:
$533,000 X 10/13 = $410,000
Hardware:
$245,000 X 5/7 = $175,000
9-30
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EXERCISE 9-17 (2025 minutes) Ending inventory: (a) Gross profit is 40% of sales Total goods available for sale (at cost)............ Sales (at selling price) ........................................... $2,300,000 Less: Gross profit (40% of sales)...................... 920,000 Sales (at cost) .............................................. Ending inventory (at cost) ....................... $2,100,000
1,380,000 $ 720,000
(b)
Gross profit is 60% of cost 60% 100% + 60% = 37.5% markup on selling price $2,100,000
Total goods available for sale (at cost)............ Sales (at selling price) ........................................... $2,300,000 Less: Gross profit (37.5% of sales) .................. 862,500 Sales (at cost) .............................................. Ending inventory (at cost) .......................
1,437,500 $ 662,500
(c)
Gross profit is 35% of sales Total goods available for sale (at cost)............ Sales (at selling price) ........................................... $2,300,000 Less: Gross profit (35% of sales)...................... 805,000 Sales (at cost) .............................................. Ending inventory (at cost) ....................... $2,100,000
1,495,000 $ 605,000
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EXERCISE 9-17 (Continued) (d) Gross profit is 25% of cost 25% 100% + 25% = 20% markup on selling price $2,100,000 $2,300,000 460,000 1,840,000 $ 260,000
Total goods available for sale (at cost) ........ Sales (at selling price)........................................ Less: Gross profit (20% of sales) ................... Sales (at cost) ....................................................... Ending inventory (at cost) ................................
EXERCISE 9-18 (2025 minutes) (a) Beginning inventory............................................ Purchases............................................................... Net markups........................................................... Totals............................................................. Net markdowns ..................................................... Sales price of goods available......................... Deduct: Sales ....................................................... Ending inventory at retail .................................. Cost $ 58,000 122,000 $180,000 Retail $100,000 200,000 20,000 320,000 (30,000) 290,000 186,000 $104,000
(b)
1. 2. 3. 4.
$180,000 $300,000 = 60% $180,000 $270,000 = 66.67% $180,000 $320,000 = 56.25% $180,000 $290,000 = 62.07%
9-32
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EXERCISE 9-18 (Continued) (c) 1. 2. 3. Method 3. Method 3. Method 3.
(d) (e) (f)
56.25% X $104,000 = $58,500 $180,000 $58,500 = $121,500 $186,000 $121,500 = $64,500
EXERCISE 9-19 (1217 minutes) Cost $ 200,000 1,425,000 1,625,000 $95,000 (15,000) Retail $ 280,000 2,140,000 2,420,000
Beginning inventory .............................. Purchases ................................................. Totals ............................................... Add: Net markups Markups ......................................... Markup cancellations ................ Totals.......................................................... Deduct: Net markdowns Markdowns..................................... Markdown cancellations............ Sales price of goods available ........... Deduct: Sales.......................................... Ending inventory at retail .................... Cost-to-retail ratio = $1,625,000 $2,500,000
_________ $1,625,000
80,000 2,500,000
35,000 (5,000)
30,000 2,470,000 2,250,000 $ 220,000
= 65%
Ending inventory at cost = 65% X $220,000 = $143,000
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EXERCISE 9-20 (2025 minutes) Cost $30,000 55,000 (2,000) 2,400 85,400 $10,000 (1,500) _______ $85,400 8,500 140,000 Retail $ 46,500 88,000 (3,000) _______ 131,500
Beginning inventory.................................... Purchases....................................................... Purchase returns ......................................... Freight on purchases ................................. Totals..................................................... Add: Net markups Markups............................................... Markup cancellations...................... Net markups .................................................. Totals..................................................... Deduct: Net markdowns Markdowns .......................................... Markdown cancellations ................. Net markdowns............................................. Sales price of goods available ................ Deduct: Net sales ($95,000 $2,000) ..... Ending inventory, at retail......................... Cost-to-retail ratio = $85,400 $140,000
9,300 (2,800) 6,500 133,500 93,000 $ 40,500
= 61%
Ending inventory at cost = 61% X $40,500 = $24,705
EXERCISE 9-21 (1015 minutes) (a) Inventory turnover: 2010 $8,923 = 6.63 times $1,344 + $1,347 2 Average days to sell inventory: 2010 365 6.63 = 55.1 days
2009 $9,458 $1,347 + $1,367 2 = 6.97 times
(b)
2009 365 6.97 = 52.4 days
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*EXERCISE 9-22 (2535 minutes) (a) Conventional Retail Method Inventory, January 1, 2013........................ Purchases (net) ............................................ Add: Net markups....................................... Totals ................................................... Deduct: Net markdowns........................... Sales price of goods available ................ Deduct: Sales (net)..................................... Ending inventory at retail.......................... Cost-to-retail ratio = $191,100 $273,000 = 70% Cost $ 41,100 150,000 191,100 $191,100 Retail $ 60,000 191,000 251,000 22,000 273,000 13,000 260,000 167,000 $ 93,000
Ending inventory at cost = 70% X $93,000 = $65,100 (b) LIFO Retail Method Inventory, January 1, 2013............................. Net purchases.................................................... Net markups ....................................................... Net markdowns.................................................. Total (excluding beginning inventory)....... Total (including beginning inventory)........ Deduct sales (net)............................................. Ending inventory at retail............................... Cost-to-retail ratio = $150,000 $200,000 = 75% Cost $ 41,100 150,000 Retail $ 60,000 191,000 22,000 (13,000) 200,000 260,000 167,000 $ 93,000
150,000 $191,100
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9-35
*EXERCISE 9-22 (Continued) Computation of ending inventory at LIFO cost, 2013:
Ending Inventory at Retail Prices $93,000 Layers at Retail Prices 2012 $60,000 2013 33,000 X X Cost-to-Retail Percentage 68.5%* 75.0% Ending Inventory at LIFO Cost $41,100 24,750 $65,850
*$41,100 (prior years cost to retail) $60,000
*EXERCISE 9-23 (1520 minutes) (a) Inventory, January 1, 2013 ........................ Net Purchases ............................................... Freight-in......................................................... Net markups................................................... Totals ..................................................... Sales ................................................................. Net markdowns ............................................. Estimated theft .............................................. Ending inventory at retail .......................... Cost-to-retail ratio: $77,000 $110,000 = 70% Cost $14,000 55,500 7,500 $77,000 Retail $ 20,000 81,000 9,000 110,000 (75,000) (2,500) (2,000) $ 30,500
Ending inventory at lower-of-average-cost-or-market = $30,500 X 70% = $21,350
9-36
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*EXERCISE 9-23 (Continued) (b) Purchases..................................................... Freight-in ...................................................... Net markups ................................................ Net markdowns........................................... Totals................................................... Cost-to-retail ratio: $63,000 $87,500 = 72% Cost $55,500 7,500 ______ $63,000 Retail $81,000 9,000 (2,500) $87,500
The increment at retail is $30,500 $20,000 = $10,500. The increment is costed at 72% X $10,500 = $7,560. Ending inventory at LIFO retail: Beginning inventory, 2013...................... Increment...................................................... Ending inventory, 2013 ............................ Cost $14,000 7,560 $21,560 Retail $20,000 10,500 $30,500
*EXERCISE 9-24 (1015 minutes) (a) Cost-to-retail ratio--beginning inventory: *($294,300 1.09) X 74% = $199,800 *Since the above computation reveals that the inventory quantity has declined below the beginning level, it is necessary to convert the ending inventory to beginning-of-the-year prices (by dividing by 1.09) and then multiply it by the beginning cost-to-retail ratio (74%). $222,000 = 74% $300,000
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*EXERCISE 9-24 (Continued) (b) Ending inventory at retail prices deflated $359,700 1.09................................................................. Beginning inventory at beginning-of-year prices..................... Inventory increase in terms of beginning-of-year dollars.............................................................. Beginning inventory (at cost).......................................................... Additional layer, $30,000 X 1.09 X 76%*.......................................
$330,000 (300,000) $ 30,000 $222,000 24,852 $246,852
*($364,800 $480,000)
*EXERCISE 9-25 (510 minutes) Ending inventory at retail (deflated) $95,150 1.10 .......................... Beginning inventory at retail..................................................................... Increment at retail......................................................................................... Ending inventory on LIFO basis First layer............................................................................................. Second layer ($12,000 X 1.10 X 55%)........................................... $86,500 (74,500) $12,000 Cost $36,000 7,260 $43,260
9-38
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*EXERCISE 9-26 (2025 minutes) (a) Beginning inventory ............................................... Net purchases........................................................... Net markups .............................................................. Totals................................................................. Net markdowns......................................................... Sales............................................................................. Ending inventory at retail...................................... Cost-retail ratio = 68% ($142,800/$210,000) Ending inventory at cost ($77,000 X 68%)....... (b) Beginning inventory ............................................... Net purchases........................................................... Net markups .............................................................. Net markdowns......................................................... Total (excluding beginning inventory).............. Total (including beginning inventory)............... Sales............................................................................. Ending inventory at retail (current).................... Ending inventory at retail (base year) ($77,000 1.10)...................................................... Cost-retail ratio for new layer: $108,500/$155,000 = 70% Layers: Base layer $50,000 X 1.00 X 68.6%* =........................ New layer ($70,000 $50,000) X 1.10 X 70% = ...... *($34,300/$50,000) (c) Cost of goods available for sale ......................... Ending inventory at cost, from (b) ..................... Cost of goods sold .................................................. $142,800 (49,700) $ 93,100 Cost $ 34,300 108,500 Cost $ 34,300 108,500 $142,800 Retail $ 50,000 150,000 10,000 210,000 (5,000) (128,000) $ 77,000
$ 52,360 Retail $ 50,000 150,000 10,000 (5,000) 155,000 205,000 (128,000) 77,000 $ 70,000
108,500 $142,800
$ 34,300 15,400 $ 49,700
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9-39
*EXERCISE 9-27 (2025 minutes) 2011 Restate to base-year retail ($121,900 1.06) Layers: 1. $100,000 X 1.00 X 54%* = 2. $ 15,000 X 1.06 X 57% = Ending inventory *$54,000 $100,000 2012 Restate to base-year retail ($138,750 1.11) Layers: 1. $100,000 X 1.00 X 54% = 2. $ 15,000 X 1.06 X 57% = 3. $ 10,000 X 1.11 X 60% = Ending inventory 2013 Restate to base-year retail ($126,500 1.15) Layers: 1. $100,000 X 1.00 X 54% = 2. $ 10,000 X 1.06 X 57% = Ending inventory 2014 Restate to base-year retail ($162,500 1.25) Layers: 1. $100,000 X 1.00 X 54% = 2. $ 10,000 X 1.06 X 57% = 3. $ 20,000 X 1.25 X 58% = Ending inventory $125,000 $ 54,000 9,063 6,660 $ 69,723 $110,000 $ 54,000 6,042 $ 60,042 $130,000 $ 54,000 6,042 14,500 $ 74,542 $115,000 $ 54,000 9,063 $ 63,063
*EXERCISE 9-28 (510 minutes) Inventory (beginning) ........................................................ Adjustment to Record Inventory at Cost* ($210,600 $205,000) .......................................... 5,600 5,600
*Note: This account is an income statement account showing the effect of changing from a lower-of-cost-or-market approach to a straight cost basis.
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Kieso, Intermediate Accounting, 14/e, Solutions Manual
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TIME AND PURPOSE OF PROBLEMS
Problem 9-1 (Time 1015 minutes) Purpose--to provide the student with an understanding of the lower-of-cost-or-market approach to inventory valuation, similar to Problem 9-2. The major difference between these problems is that Problem 9-1 provides some ambiguity to the situation by changing the catalog prices near the end of the year. Problem 9-2 (Time 2530 minutes) Purpose--to provide the student with an understanding of the lower-of-cost-or-market approach to inventory valuation. The student is required to examine a number of individual items and apply the lower-of-cost-or-market rule and to also explain the use and value of the lower-of-cost-or-market rule. Problem 9-3 (Time 3035 minutes) Purpose--to provide a problem that requires entries for reducing inventory to lower-of-cost-or-market under the perpetual inventory system using both the cost-of-goods-sold and the loss methods. Problem 9-4 (Time 2030 minutes) Purpose--to provide another problem where a fire loss must be computed using the gross profit method. Certain goods remained undamaged and therefore an adjustment is necessary. In addition, the inventory was subject to an obsolescence factor which must be considered. Problem 9-5 (Time 4045 minutes) Purpose--to provide the student with a complex problem involving a fire loss where the gross profit method must be employed. The problem is complicated because a number of adjustments must be made to the purchases account related to merchandise returned, unrecorded purchases, and shipments in transit. In addition, some cash to accrual computations are necessary. Problem 9-6 (Time 2030 minutes) Purpose--to provide the student with a problem on the retail inventory method. The problem is relatively straightforward although transfers-in from other departments as well as the proper treatment for normal spoilage complicate the problem. A good problem that summarizes the essentials of the retail inventory method. Problem 9-7 (Time 2030 minutes) Purpose--to provide the student with a problem on the retail inventory method. This problem is similar to Problem 9-6, except that a few different items must be evaluated in finding ending inventory at retail and cost. Unusual items in this problem are employee discounts granted and loss from breakage. A good problem that summarizes the essentials of the retail inventory method. Problem 9-8 (Time 2030 minutes) Purpose--to provide the student with a problem on the retail inventory method. This problem is similar to Problems 9-6 and 9-7, except that the student is asked to list the factors that may have caused the difference between the computed inventory and the physical count. Problem 9-9 (Time 3040 minutes) Purpose--to provide the student with a problem requiring financial statement and note disclosure of inventories, the income statement disclosure of an inventory market decline, and the treatment of purchase commitments. Problem 9-10 (Time 3040 minutes) Purpose--to provide the student with an opportunity to write a memo explaining what is designated market value and how it is computed. As part of this memo, the student is required to compute inventory on the lower-of-cost-or-market basis using the individual item approach.
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Time and Purpose of Problems (Continued) *Problem 9-11 (Time 3035 minutes) Purpose--to provide the student with a retail inventory problem where both the conventional retail and dollar-value LIFO method must be computed. An excellent problem for highlighting the difference between these two approaches to inventory valuation. It should be noted that the cost-to-retail percentage is given for LIFO so less computation is necessary. *Problem 9-12 (Time 3040 minutes) Purpose--to provide the student with a comprehensive problem covering the retail and LIFO retail inventory methods, the computation of an inventory shortage, and the treatment of four special items relative to the retail inventory method. *Problem 9-13 (Time 3040 minutes) Purpose--to provide the student with a basic problem illustrating the change from conventional retail to LIFO retail. This problem emphasizes many of the same issues as Problem 9-11, except that a dollarvalue LIFO computation is not needed. A good problem for providing the essential issues related to a change to LIFO retail. *Problem 9-14 (Time 4050 minutes) Purpose--to provide the student with a retail inventory problem where both the conventional retail and dollar-value LIFO method must be computed. The problem is similar to Problem 9-10, except that the problem involves a three-year period which adds complexity to the problem. This problem provides an excellent summary of the essential elements related to the change of the retail inventory method from conventional retail to LIFO retail and dollar-value LIFO retail.
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Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Manual
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SOLUTIONS TO PROBLEMS
PROBLEM 9-1
Item A B C D
Cost $470 450 830 960
Replacement Cost $ 460 430 610 1,000
Ceiling* $ 450 480 820 1,070
Floor** $350 372 640 830
Designated Market $ 450 430 640 1,000
Lower-ofCost-orMarket $450 430 640 960
*Ceiling = 2013 catalog selling price less sales commissions and estimated other costs of disposal. (2013 catalogue prices are in effect as of 12/01/12.) **Floor = Ceiling less (20% X 2013 catalog selling price).
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9-43
PROBLEM 9-2
(a)
1.
The balance in the Allowance to Reduce Inventory to Market at May 31, 2012, should be $34,600, as calculated in Exhibit 1 below.
Exhibit 1 CALCULATIONS OF PROPER BALANCE in the Allowance to Reduce Inventory to Market At May 31, 2012 Replacement Cost $ 62,500 79,400 124,000 126,000 $391,900 NRV less normal profit (Floor) $ 50,900 77,400 149,800 124,600 $402,700
Cost Aluminum siding Cedar shake siding Louvered glass doors Thermal windows Totals $ 70,000 86,000 112,000 140,000 $408,000
NRV (Ceiling) $ 56,000 84,800 168,300 140,000 $449,100
LCM $ 56,000 79,400 112,000 126,000 $373,400
Inventory cost LCM valuation Allowance at May 31, 2012
$408,000 373,400 $ 34,600
2.
For the fiscal year ended May 31, 2012, the loss that would be recorded due to the change in the Allowance to Reduce Inventory to Market would be $7,100, as calculated below. Balance prior to adjustment ...................................... Required balance .......................................................... Loss to be recorded ..................................................... $27,500 (34,600) $( 7,100)
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Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 9-2 (Continued) (b) The use of the lower-of-cost-or-market (LCM) rule is based on both the expense recognition principle and the concept of conservatism. The expense recognition principle applies because the application of the LCM rule allows for the recognition of a decline in the utility (value) of inventory as a loss in the period in which the decline takes place. The departure from the cost principle for inventory valuation is permitted on the basis of conservatism. The general rule is that the historical cost principle is abandoned when the future utility of an asset is no longer as great as its original cost.
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PROBLEM 9-3
(a)
12/31/12 (Cost-of-goods-sold Method) Cost of Goods Sold ........................................................... 68,000 Inventory .................................................................... 12/31/13 Cost of Goods Sold ........................................................... Inventory ....................................................................
68,000
75,000 75,000
(b)
12/31/12 (Loss Method) To write down inventory to market: Loss Due to Market Decline of Inventory................... Allowance to Reduce Inventory to Market ...... 12/31/13 To write down inventory to market: Loss Due to Market Decline of Inventory................... Allowance to Reduce Inventory to Market [($905,000 $830,000) $68,000] ...................
68,000 68,000
7,000 7,000
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Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 9-4
Beginning inventory ............................................................... Purchases .................................................................................. Purchase returns ..................................................................... Total goods available ............................................................. Sales ............................................................................................ $415,000 Sales returns............................................................................. (21,000) 394,000 Less: Gross profit (35% of $394,000)............................... 137,900 Ending inventory (unadjusted for damage).................... Less: Goods on hand--undamaged ($30,000 X [1 35%]) ................................................. Inventory damaged ................................................................. Less: Salvage value of damaged inventory .................. Fire loss on inventory ............................................................
$ 80,000 290,000 370,000 (28,000) 342,000
(256,100) 85,900 19,500 66,400 8,150 $ 58,250
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PROBLEM 9-5
STANISLAW CORPORATION Computation of Inventory Fire Loss April 15, 2013 Inventory, 1/1/13 .................................................... Purchases, 1/1/ 3/31/13 .................................... April merchandise shipments paid................. Unrecorded purchases on account ................ Total .............................................................. Less: Shipments in transit................................ Merchandise returned ........................... Merchandise available for sale......................... Less estimated cost of sales: Sales, 1/1/ 3/31/13.................................. Sales, 4/1/ 4/15/13 Receivables acknowledged at 4/15/13 ........................................... Estimated receivables not acknowledged ................................. Total ....................................................... Add collections, 4/1/ 4/15/13 ($12,950 $950) ..................................... Total ....................................................... Less receivables, 3/31/13....................... Total sales 1/1/ 4/15/13 ................. Less gross profit (45%* X $161,000)............... Estimated merchandise inventory .................. Less: Sale of salvaged inventory ................... Inventory fire loss................................................. $ 75,000 52,000 3,400 15,600 146,000 $ 2,300 950 3,250 142,750
135,000
$46,000 8,000 54,000 12,000 66,000 40,000
26,000 161,000 72,450
88,550 54,200 3,500 $ 50,700
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Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 9-5 (Continued) *Computation of Gross Profit Rate Net sales, 2011 ......................................................... Net sales, 2012 ......................................................... Total net sales .............................................. Beginning inventory ............................................... Net purchases, 2011 ............................................... Net purchases, 2012 ............................................... Total................................................................. Less: Ending inventory ........................................ Gross profit.................................................. Gross profit rate ($414,000 $920,000)............ $390,000 530,000 920,000 $ 66,000 235,000 280,000 581,000 75,000
506,000 $414,000 45%
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PROBLEM 9-6
(a) Beginning Inventory................................ Purchases................................................... Freight-in..................................................... Purchase returns...................................... Transfers in from suburban branch................................... Totals................................................. Net markups............................................... Net markdowns ......................................... Sales ............................................................. Sales returns.............................................. Inventory losses due to breakage ...... Ending inventory at retail ...................... Cost-to-retail ratio = (b) $113,400 $180,000
Cost $ 17,000 82,500 7,000 (2,300) 9,200 $113,400
Retail $ 25,000 137,000 (3,000) 13,000 172,000 8,000 180,000 (4,000) $(95,000) 2,400 (92,600) (400) $ 83,000
= 63%
Ending inventory at lower-of-average-cost-or-market (63% of $83,000) ....................................
$ 52,290
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Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 9-7
Cost Beginning Inventory ............................... Purchases .................................................. Purchase returns ..................................... Purchase discounts................................ Freight-in .................................................... Markups ...................................................... Markup cancellations ............................. Totals ................................................ Markdowns ................................................ Markdown cancellations ....................... Sales ............................................................ Sales returns............................................. Inventory losses due to breakage...... Employee discounts............................... Ending inventory at retail ..................... Cost-to-retail ratio = $ 250,000 914,500 (60,000) (18,000) 42,000 $ $1,128,500 (45,000) 20,000 (1,410,000) 97,500 120,000 (40,000)
Retail $ 390,000 1,460,000 (80,000)
80,000 1,850,000 (25,000) (1,312,500) (4,500) (8,000) $ 500,000
$1,128,500 = 61% $1,850,000
Ending inventory at cost (61% of $500,000) .................................
$ 305,000
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Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 9-8
(a) Inventory (beginning) ......................... Purchases............................................... Purchase returns.................................. Freight-in................................................. Totals............................................. Markups................................................... Markup cancellations.......................... Net markdowns ..................................... Normal spoilage and breakage........ Sales ......................................................... Ending inventory at retail .................. Cost-to-retail ratio = $335,000 $500,000
Cost $ 52,000 272,000 (5,600) 16,600 $335,000 9,000 (2,000)
Retail $ 78,000 423,000 (8,000) 493,000 7,000 500,000 (3,600) (10,000) (390,000) $ 96,400
= 67%
Ending inventory at lower-of-cost-or-market (67% of $96,400) ................................ (b)
$ 64,588
The difference between the inventory estimate per retail method and the amount per physical count may be due to: 1. Theft losses (shoplifting or pilferage). 2. Spoilage or breakage above normal. 3. Differences in cost/retail ratio for purchases during the month, beginning inventory, and ending inventory. 4. Markups on goods available for sale inconsistent between cost of goods sold and ending inventory. 5. A wide variety of merchandise with varying cost/retail ratios. 6. Incorrect reporting of markdowns, additional markups, or cancellations.
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Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 9-9
(a)
The inventory section of Maddox's balance sheet as of November 30, 2012, including required footnotes, is presented below. Also presented below are the inventory section supporting calculations. Current assets Inventory Section (Note 1.) Finished goods (Note 2.) ............................. Work-in-process ............................................. Raw materials.................................................. Factory supplies............................................. Total inventories............................................. Note 1.
$643,000 108,700 237,400 64,800 $1,053,900
Lower-of-cost (first-in, first-out) or-market is applied on a major category basis for finished goods, and on a total inventory basis for work-in-process, raw materials, and factory supplies. Seventy-five percent of bar end shifters finished goods inventory in the amount of $136,500 ($182,000 X .75) is pledged as collateral for a bank loan, and one-half of the head tube shifters finished goods is held by catalog outlets on consignment.
Note 2.
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PROBLEM 9-9 (Continued) Supporting Calculations
Finished Goods $266,000 182,000 195,000 Work-inProcess Raw Materials Factory Supplies
Down tube shifters at market.......... Bar end shifters at cost..................... Head tube shifters at cost................ Work-in-process at market .............. Derailleurs at market.......................... Remaining items at market.............. Supplies at cost................................... Totals ..........................................
1 2
$108,700 $110,0001 127,400 $643,000 $108,700 $237,400 $64,8002 $64,800
$264,000 X 1/2 = $132,000; $132,000 1.2 = $110,000. $69,000 $4,200 = $64,800.
(b)
The decline in the market value of inventory below cost may be reported using one or two alternate methods, the direct write-down of inventory (cost-of-goods-sold method) or the (loss method). An allowance may be used under either method to report inventory on the balance sheet at LCM. The decline in the market value of inventory may be reflected in Maddox's income statement as a separate loss item for the fiscal year ended November 30, 2012. The loss amount may also be written off directly, increasing the cost of goods sold on Maddox's income statement. The loss must be reported in continuing operations rather than in extraordinary items. The loss must be included in the income statement since it is material to Maddox's financial statements. Purchase contracts for which a firm price has been established should be disclosed on the financial statements of the buyer. If the contract price is greater than the current market price and a loss is expected when the purchase takes place, an unrealized holding loss amounting to the difference between the contracted price and the current market price should be recognized on the income statement in the period during which the price decline takes place. Also, an estimated liability on purchase commitments should be recognized on the balance sheet. The recognition of the loss is unnecessary if a firm sales commitment exists which precludes the loss.
(c)
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Kieso, Intermediate Accounting, 14/e, Solutions Manual
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PROBLEM 9-10
(a)
Schedule A
NRV-- Normal Profit (Floor) $7.20 7.30 5.45 4.00 5.00 Lower-ofCost-orMarket $7.50 7.90 5.45 3.80 6.00
Item A B C D E
On Hand Quantity 1,100 800 1,000 1,000 1,400
Replacement Cost/Unit $8.40 7.90 5.40 4.20 6.30
NRV (Ceiling) $9.00 8.50 6.05 5.50 6.00
Designated Market $8.40 7.90 5.45 4.20 6.00
Cost $7.50 8.20 5.60 3.80 6.40
Schedule B Item A B C D E Cost 1,100 X $7.50 = $8,250 800 X $8.20 = $6,560 1,000 X $5.60 = $5,600 1,000 X $3.80 = $3,800 1,400 X $6.40 = $8,960 Lower-of-Cost-or-Market 1,100 X $7.50 = $8,250 800 X $7.90 = $6,320 1,000 X $5.45 = $5,450 1,000 X $3.80 = $3,800 1,400 X $6.00 = $8,400 Difference None $240 $150 None $560 $950 950 950
(b)
Cost of Goods Sold............................................................. Allowance to Reduce Inventory to Market......... or Loss Due to Market Decline of Inventory ................... Allowance to Reduce Inventory to Market.........
950 950
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Kieso, Intermediate Accounting, 14/e, Solutions Manual
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9-55
PROBLEM 9-10 (Continued) (c) To: From: Date: Subject: Greg Forda, Clerk Accounting Manager January 14, 2013 Instructions on determining lower-of-cost-or-market for inventory valuation
This memo responds to your questions regarding our use of lower-of-costor-market for inventory valuation. Simply put, value inventory at whichever is the lower: the actual cost or the market value of the inventory at the time of valuation. The term cost is relatively simple. It refers to the amount our company paid for our inventory including costs associated with preparing the inventory for sale. The term market, on the other hand, is more complicated. As you have already noticed, this value could be the inventory's replacement cost, its net realizable value (selling price minus any estimated costs to complete and sell), or its net realizable value less a normal profit margin. The profession requires that the middle value of the three above costs be chosen as the "designated market value." This designated market value is then compared to the actual cost in determining the lower-of-cost-ormarket. Refer to Item A on the attached schedule. The values for the replacement cost, net realizable value, and net realizable value less a normal profit margin are $8.40, $9.00 ($10.50 $1.50), and $7.20 ($9.00 $1.80) respectively. The middle value is the replacement cost, $8.40, which becomes the designated market value for Item A. Compare it with the actual cost, $7.50, choosing the lower to value Item A in inventory. In this case, $7.50 is the value chosen to value inventory. Thus, inventory for Item A amounts to $8,250. (See Schedule B, Item A.)
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PROBLEM 9-10 (Continued) Proceed in the same way, always choosing the middle value among replacement cost, net realizable value, and net realizable value less a normal profit, and compare that middle value to the actual cost. The lower of these will always be the amount at which you value the particular item. After you have aggregated the total lower-of-cost-or-market for all items, you will be likely to have a loss on inventory which must be accounted for. In our example, the loss is $950. You can journalize this loss in one of two ways: Cost of Goods Sold ........................................................................... Allowance to Reduce Inventory to Market ...................... or Loss Due to Market Decline of Inventory ................................... Allowance to Reduce Inventory to Market ...................... 950 950 950 950
This memo should answer your questions about which value to choose when valuing inventory at lower-of-cost-or-market. Schedule A
NRV-- Normal Profit (Floor) $7.20 7.30 5.45 4.00 5.00 Lower-ofCost-orMarket $7.50 7.90 5.45 3.80 6.00
Item A B C D E
On Hand Quantity 1,100 800 1,000 1,000 1,400
Replacement Cost/Unit $8.40 7.90 5.40 4.20 6.30
NRV Ceiling $9.00 8.50 6.05 5.50 6.00
Designated Market $8.40 7.90 5.45 4.20 6.00
Cost $7.50 8.20 5.60 3.80 6.40
Schedule B Item A B C D E Cost 1,100 X $7.50 = $8,250 800 X $8.20 = $6,560 1,000 X $5.60 = $5,600 1,000 X $3.80 = $3,800 1,400 X $6.40 = $8,960 Lower-of-Cost-or-Market 1,100 X $7.50 = $8,250 800 X $7.90 = $6,320 1,000 X $5.45 = $5,450 1,000 X $3.80 = $3,800 1,400 X $6.00 = $8,400 Difference None $240 $150 None $560 $950
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*PROBLEM 9-11
(a) Inventory, January 1............................ Purchases............................................... Purchase returns.................................. Totals............................................. Add: Net markups Markups....................................... Markup cancellations.............. Totals............................................. Deduct: Net markdowns Markdowns .................................. Markdown cancellations ......... Sales price of goods available......... Sales ......................................................... Sales returns and allowances.......... Ending inventory at retail .................. Cost-to-retail ratio = $132,000 $200,000
Cost $ 30,000 104,800 (2,800) 132,000 $ $132,000 $ 10,500 (6,500) $154,000 (8,000) 9,200 (3,200)
Retail $ 43,000 155,000 (4,000) 194,000
6,000 200,000
4,000 196,000 (146,000) $ 50,000
= 66%
Inventory at lower-of-cost-ormarket (66% X $50,000)................... (b) Ending inventory at retail at January 1 price level ($59,400 1.08).............................................................................. Less beginning inventory at retail.............................................. Inventory increment at retail, January 1 price level ............. Inventory increment at retail, June 30 price level ($12,000 X 1.08).............................................................................. Beginning inventory at cost ......................................................... Inventory increment at cost at June 30 price level ($12,960 X 70%) ............................................................................. Ending inventory at dollar-value LIFO cost.............................
$ 33,000
$ 55,000 43,000 $ 12,000 $ 12,960 $ 30,000 9,072 $ 39,072
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*PROBLEM 9-12
(a)
The retail method is appropriate in businesses that sell many different items at relatively low unit costs and that have a large volume of transactions such as Sears or Wal-Mart. The advantages of the retail method in these circumstances include the following: 1. Interim physical inventories can be estimated. 2. The retail method acts as a control as deviations from the physical count will have to be explained. Becker Department Stores' ending inventory value, at cost, is $83,000, calculated as follows: Cost $ 68,000 $255,000 Retail $100,000 $400,000 50,000 (110,000) 340,000 440,000 (320,000) $120,000
(b)
Beginning inventory ........................................... Purchases .............................................................. Net markups ............................................... Net markdowns.......................................... Net purchases ............................................ Goods available ................................................... Sales ........................................................................ Estimated ending inventory at retail.............
$255,000
Cost-to-retail percentage: $255,000 $340,000 = 75%. Beginning inventory layer ................................ Incremental increase At retail ($120,000 $100,000) .............. At cost ($20,000 X 75%) .......................... Estimated ending inventory at LIFO cost.... $ 68,000 $100,000 20,000 15,000 $ 83,000 $120,000
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*PROBLEM 9-12 (Continued) (c) The estimated shortage amount, at retail, for Becker Department Stores is $5,000 calculated as follows: Estimated ending inventory at retail ..................................... Actual ending inventory at retail ............................................ Estimated inventory shortage ................................................. (d) $120,000 (115,000) $ 5,000
When using the retail inventory method, the four expenses and allowances noted are treated in the following manner: 1. Freight costs are added to the cost of purchases. 2. Purchase returns and allowances are considered as reductions to both the cost price and the retail price. 3. Sales returns and allowances are subtracted as an adjustment to sales. 4. Employee discounts are deducted from the retail column in a manner similar to sales. They are not considered in the cost-toretail percentage because they do not reflect an overall change in the selling price.
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*PROBLEM 9-13
(a) Inventory (beginning) .......................... Purchases ............................................... Markups ................................................... Totals ............................................. Markdowns.............................................. Sales.......................................................... Ending inventory at retail................... Cost-to-retail ratio = $132,000 $220,000
Cost $ 15,800 116,200 $132,000
Retail $ 24,000 184,000 12,000 220,000 (5,500) (175,000) $ 39,500
= 60% $ 23,700
Ending inventory at cost (60% X $39,500) (b) Ending inventory for 2012 under the LIFO method: The cost-to-retail ratio for 2012 can be computed as follows:
Net purchases at cost $116,200 = Net purchases plus markups less markdowns at retail $184,000 + $12,000 $5,500
= 61%
December 31, 2012, inventory at LIFO cost: Retail $24,000 15,500* $39,500 Ratio 59% 61% LIFO Cost $14,160 9,455 $23,615
Beginning inventory ................ Increment in 2012 ..................... Ending inventory ...................... *$39,500 $24,000 = $15,500
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*PROBLEM 9-14
(a)
DAVENPORT DEPARTMENT STORE COMPUTATION OF COST OF DECEMBER 31, 2011, INVENTORY BASED ON THE CONVENTIONAL RETAIL METHOD At Cost At Retail $ 56,000 554,000 (10,000) $ 29,800 311,000 (5,200) (6,000) 17,600 $347,200
Beginning inventory, January 1, 2011 ................. Add (deduct) transactions affecting cost ratio: Gross purchases ............................................ Purchase returns ............................................ Purchase discounts....................................... Freight-in ........................................................... Net markups ..................................................... Totals ........................................................... Add (deduct) other retail transactions not considered in computation of cost ratio: Gross sales....................................................... Sales returns.................................................... Net markdowns ............................................... Employee discounts...................................... Totals ........................................................... Inventory, December 31, 2011: At retail............................................................... At cost ($63,000 X 56%*) .............................. *Ratio of cost-to-retail = $347,200 $620,000 = 56%
20,000 620,000
(551,000) 9,000 (12,000) (3,000) (557,000) $ 63,000 $ 35,280
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*PROBLEM 9-14 (Continued) (b) COMPUTATION OF COST OF DECEMBER 31, 2011 INVENTORY UNDER THE LIFO RETAIL METHOD Cost Totals used in computing cost ratio under conventional retail method (part a).................... Exclude beginning inventory................................... Net purchases............................................................... Deduct net markdowns.............................................. Totals used on computing cost ratio under LIFO retail method ................................................... Cost ratio under LIFO retail method ($317,400 $552,000).............................................. Inventory, December 31, 2011: At Retail (Conventional)................................ At Cost under LIFO retail method ($60,000 X 57.5%)......................................... $347,200 29,800 317,400 Retail $620,000 56,000 564,000 12,000 $552,000
$317,400
57.5% $ 60,000 $ 34,500
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*PROBLEM 9-14 (Continued) (c) COMPUTATION OF 2012 AND 2013 YEAR-END INVENTORIES UNDER THE DOLLAR-VALUE LIFO METHOD Cost 2012: Inventory at end of year (given)....................... Inventory at end of year stated in terms of January 1, 2012 prices ($75,600 105%)................................................ January 1, 2012 inventory base (given) cost ratio of 55.5% ($33,300 $60,000)...... Increment in inventory: In terms of January 1, 2012 prices.................. In terms of 2012 prices--$12,000 X 105%..... At LIFO cost--61% (2012 cost ratio) X $12,600.................................................................. December 1, 2012 inventory at LIFO cost................. 2013: Inventory at end of year (given)....................... Inventory at end of year stated in terms of January 1, 2013 prices ($62,640 108%)................................................ December 31, 2013 inventory at LIFO cost--55.5%* (January 1, 2012 cost ratio) X $58,000 .................................................. *Based on the beginning inventory for 2012 of $62,640 $75,600 Retail
Computation of retail values on the basis of January 1, 2012, price levels
72,000 $33,300 60,000 $12,000 $12,600 7,686 $40,986
$58,000
$32,190
$33,300 Cost = 55.5%. $60,000 Retail
(Note to instructor: Because the retail inventory stated in terms of January 1, 2012 prices at December 31, 2012, $58,000, has fallen below the January 1, 2013 inventory base at retail, $60,000, under the LIFO theory the 2013 layer has been depleted and only a portion of the original inventory base remains. Hence the LIFO cost at December 31, 2013 is determined by applying the January 1, 2012 cost ratio of 55.5 percent to the retail inventory value of $58,000).
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TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 9-1 (Time 1525 minutes) Purpose--to provide the student with an opportunity to discuss the purpose, the application, and the potential disadvantages of the lower-of-cost-or-market method. In addition, the student is asked to discuss the ceiling and floor constraints for determining "market" value. CA 9-2 (Time 2030 minutes) Purpose--to provide the student with an opportunity to examine ethical issues related to lower-of-costor-market on an individual-product basis. A relatively straightforward case. CA 9-3 (Time 1520 minutes) Purpose--to provide the student with a case that requires an application and an explanation of the lower-of-cost-or-market rule and a differentiation of the LIFO and the average cost methods. CA 9-4 (Time 2530 minutes) Purpose--to provide the student with an opportunity to discuss the main features of the retail inventory system. In this case, the following must be explained: (a) accounting features of the method, (b) conditions that may distort the results under the method, (c) advantages of using the retail method versus using a cost method, and (d) the accounting theory underlying net markdowns and net markups. A relatively straightforward case. CA 9-5 (Time 1525 minutes) Purpose--the student discusses which costs are inventoriable, the theoretical arguments for the lowerof-cost-or-market rule, and the amount that should be used to value inventories when replacement cost is below the net realizable value less a normal profit margin. The treatment of beginning inventories and net markdowns when using the conventional retail inventory method must be explained. CA 9-6 (Time 1015 minutes) Purpose--to provide the student with a case that allows examination of ethical issues related to the recording of purchase commitments. *CA 9-7 (Time 1015 minutes) Purpose--to provide the student with a number of items that might be encountered when a conventional retail or LIFO retail problem develops. The student must determine whether items, such as markdowns, markdown cancellations, sales discounts, etc. should be considered in computing the cost-to-retail percentage.
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SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 9-1
(a) The purpose of using the lower-of-cost-or-market method is to reflect the decline of inventory value below its original cost. A departure from cost is justified on the basis that a loss of utility should be reported as a charge against the revenues in the period in which it occurs. (b) The term "market" in the phrase "the lower-of-cost-or-market" generally means the cost to replace the item by purchase or reproduction. Market is limited, however, to an amount that should not exceed the net realizable value (the "ceiling") (that is, the estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal) and should not be less than net realizable value reduced by an allowance for an approximately normal profit margin (the "floor"). The "ceiling" covers obsolete, damaged, or shopworn material and prevents serious overstatement of inventory. The "floor," on the other hand, deters serious understatement of inventory. (c) The lower-of-cost-or-market method may be applied either directly to each inventory item, to a category, or to the total inventory. The application of the rule to the inventory total, or to the total components of each category, ordinarily results in an amount that more closely approaches cost than it would if the rule were applied to each individual item. Under the first two methods, increases in market prices offset, to some extent, the decreases in market prices. The most common practice is, however, to price the inventory on an item-by-item basis. Companies favor the individual item approach because tax rules require that an individual item basis be used unless it involves practical difficulties. In addition, the individual item approach gives the most conservative valuation for balance sheet purposes.
(d) Conceptually, the lower-of-cost-or-market method has some deficiencies. First, decreases in the value of the asset and the charge to expense are recognized in the period in which loss in utility occurs--not in the period of sale. On the other hand, increases in the value of the asset are recognized only at the point of sale. This situation is inconsistent and can lead to distortions in the presentation of income data. Second, there is difficulty in defining "market" value. Basically, three different types of valuation can be used: replacement cost, net realizable value, and net realizable value less a normal markup. A reduction in the replacement cost of an item does not necessarily indicate a corresponding reduction in the utility (price) of the item. To recognize a loss in one period may misstate the period's income and also that of future periods because when the merchandise is sold subsequently, the full price for the item is received. Net realizable value reflects the future service potential of the asset and, for that reason, it is conceptually sound. But net realizable value cannot often be measured with any certainty. Therefore, we revert to replacement cost because net realizable value less a normal markup is even more uncertain than net realizable value. From the standpoint of accounting theory there is little to justify the lower-of-cost-or-market rule. Although conservative from the balance sheet point of view, it permits the income statement to show a larger net income in future periods than would be justified if the inventory were carried forward at cost. The rule is applied only in those cases where strong evidence indicates that market declines in inventory prices have occurred that will result in losses when such inventories are disposed of.
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CA 9-2
(a) The accountant's ethical responsibility is to provide fair and complete financial information. In this case, the direct method distorts the cost of goods sold and hides the decline in market value. (b) If Wright's cost-of-goods-sold method is used, management may have difficulty in calculations that involve the cost of goods sold. For example, these calculations are useful in establishing profit margins and determining selling prices; but from the investors' and stockholders' viewpoint, it is not good policy to hide declines in market value. (c) Conan should use the loss method to disclose the decline in market value and avoid distorting cost of goods sold. However, she faces an ethical dilemma if Wright will not accept the method Conan wants to use. She should consider various alternatives including the extremes of simply accepting her boss's decision to quitting if Wright will not change his mind. Conan should assess the consequences of each possible alternative and weigh them carefully before she decides what to do.
CA 9-3
(a) 1. Ogala's inventory should be reported at net realizable value. According to the lower-of-cost-ormarket rule, market is defined as replacement cost. However, market cannot exceed net realizable value. In this instance, net realizable value is below original cost. 2. The lower-of-cost-or-market rule is used to report the inventory in the balance sheet at its future utility value. It also recognizes a decline in the utility of inventory in the income statement in the period in which the decline occurs. (b) Generally, ending inventory would have been higher and cost of goods sold would have been lower had Ogala used the LIFO inventory method in a period of declining prices. Inventory quantities increased and LIFO associates the oldest purchase prices with inventory. However, in this instance, there would have been no effect on ending inventory or cost of goods sold had Ogala used the LIFO inventory method because Ogala's inventory would have been reported at net realizable value according to the lower-of-cost-or-market rule. Net realizable value of the inventory is less than either its average cost or LIFO cost.
CA 9-4
(a) The retail inventory method can be employed to estimate retail, wholesale, and manufacturing finished goods inventories. The valuation of inventory under this method is arrived at by reducing the ending inventory at retail to an estimate of the lower-of-cost-or-market. The retail value of ending inventory can be computed by (1) taking a physical inventory, or by (2) subtracting net sales and net markdowns from the total retail value of merchandise available for sale (i.e., the sum of beginning inventory at retail, net purchases at retail, and net markups). The reduction of ending inventory at retail to an estimate of the lower-of-cost-or-market is accomplished by applying to it an estimated cost ratio arrived at by dividing the retail value of merchandise available for sale as computed in (2) above into the cost of merchandise available for sale (i.e., the sum of beginning inventory, net purchases, and other inventoriable costs).
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CA 9-4 (Continued)
(b) Since the retail method is based on an estimated cost ratio involving total merchandise available during the period, its validity depends on the underlying assumption that the merchandise in ending inventory is a representative mixture of all merchandise handled. If this condition does not exist, the cost ratio may not be appropriate for the merchandise in ending inventory and can result in significant error. Where there are a number of inventory subdivisions for which differing rates of markup are maintained, there is no assurance that the ending inventory mix will be representative of the total merchandise handled during the period. In such cases accurate results can be obtained by subclassifications by rate of markup. Seasonal variations in the rate of markup will nullify the ending inventory "representative mix" assumption. Since the estimated cost ratio is based on total merchandise handled during the period, the same rate of markup should prevail throughout the period. Because of seasonal variations it may be necessary to use data for the last six months, quarter, or month to compute a cost ratio that is appropriate for ending inventory. Material quantities of special sale merchandise handled during the period may also bias the result of this method because merchandise data included in arriving at the estimated cost ratio may not be proportionately represented in ending inventory. This condition may be avoided by accumulating special sale merchandise data in separate accounts. Distortion of the ending inventory approximation under this method is often caused by an inadequate system of inventory control. Adequate accounting controls are necessary for the accurate accumulation of the data needed to arrive at a valid cost ratio. Physical controls are equally important because, for interim purposes, this method is usually applied without taking a physical inventory. (c) The advantages of using the retail method as compared to cost methods include the following: 1. Approximate inventory values can be determined without maintaining perpetual inventory records. 2. The preparation of interim financial statements is facilitated. 3. Losses due to fire or other casualty are readily determined. 4. Clerical work in pricing the physical inventory is reduced. 5. The cost of merchandise can be kept confidential in intracompany transfers. (d) The treatments to be accorded net markups and net markdowns must be considered in light of their effects on the estimated cost ratio. If both net markups and net markdowns are used in arriving at the cost ratio, ending inventory will be converted to an estimated average cost figure. Excluding net markdowns will result in the inventory being stated at an estimate of the lower-ofcost-or-market. The lower cost ratio arrived at by excluding net markdowns permits the pricing of inventory at an amount that reflects its current utility. The assumption is that net markdowns represent a loss of utility that should be recognized in the period of markdown. Ending inventory is therefore valued on the basis of its revenue-producing potential and may be expected to produce a normal gross profit if sold at prevailing retail prices in the next period.
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CA 9-5
(a) 1. Olson's inventoriable cost should include all costs incurred to get the lighting fixtures ready for sale to the customer. It includes not only the purchase price of the fixtures but also the other associated costs incurred on the fixtures up to the time they are ready for sale to the customer, for example, freight-in. 2. No, administrative costs are assumed to expire with the passage of time and not to attach to the product. Furthermore, administrative costs do not relate directly to inventories, but are incurred for the benefit of all functions of the business. (b) 1. The lower-of-cost-or-market rule is used for valuing inventories because of the concept of balance sheet conservatism and because the decline in the utility of the inventories below their cost should be recognized as a loss in the current period. 2. The net realizable value less a normal profit margin should be used to value the inventories because market should not be less than net realizable value less a normal profit margin. To carry the inventories at net realizable value less a normal profit margin provides a means of measuring residual usefulness of an inventory expenditure. (c) Olson's beginning inventories at cost and at retail would be included in the calculation of the cost ratio. Net markdowns would be excluded from the calculation of the cost ratio. This procedure reduces the cost ratio because there is a larger denominator for the cost ratio calculation. Thus, the concept of balance sheet conservatism is being followed and a lower-of-cost-or-market valuation is approximated.
CA 9-6
(a) Accounting standards require that when a contracted price is in excess of market, as it is in this case (market is $5,000,000 and the contract price is $6,000,000), and it is expected that losses will occur when the purchase is effected, losses should be recognized in the period during which such declines in market prices take place. It would be unethical to ignore recognition of the loss now if a loss is expected to occur when the purchase is effected. (b) If the loss is material, new and continuing shareholders are harmed by nonrecognition of the loss. Herman's position as an accounting professional also is affected if he accepts a financial report he knows violates GAAP. (c) If the preponderance of the evidence points to a loss when the purchase is effected, the controller should recognize the amount of the loss in the period in which the price decline occurs. In this case the loss is measured at $1,000,000 and recorded as follows: Unrealized Holding Gain or Loss--Income (Purchase Commitments) .......................................................................... Estimated Liability on Purchase Commitments ............................. 1,000,000 1,000,000
Herman should insist on statement preparation in accordance with GAAP. If Hands will not accept Herman's position, Herman will have to consider alternative courses of action such as contacting higher-ups at Prophet and assess the consequences of each course of action.
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*CA 9-7
(a) Conventional retail 3. Cost of items transferred in from other departments. 4. Retail value of items transferred in from other departments. 6. Purchase discounts. 8. Cost of beginning inventory. 9. Retail value of beginning inventory. 10. Cost of purchases. 11. Retail value of purchases. 12. Markups. 13. Markup cancellations. (b) LIFO retail 1. Markdowns. 2. Markdown cancellations. 3. Cost of items transferred in from other departments. 4. Retail value of items transferred in from other departments. 6. Purchase discounts. 10. Cost of purchases. 11. Retail value of purchases. 12. Markups. 13. Markup cancellations.
(Note to instructor: If the goods broken or stolen are abnormal shrinkage, they are deducted from both the cost and retail columns.)
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FINANCIAL REPORTING PROBLEM
(a)
Inventories are valued at the lower-of-cost-or-market value. Productrelated inventories are primarily maintained on the first-in, first-out method. Minor amounts of product inventories, including certain cosmetics and commodities are maintained on the last-in, first-out method. The cost of spare part inventories is maintained using the average cost method.
(b) Inventories are reported on the balance sheet simply as "inventories" with sub-totals reported for (1) Materials and supplies, (2) Work in process, and (3) Finished goods. (c) In its note describing Cost of Products Sold, P&G indicates that cost of products sold is primarily comprised of direct materials and supplies consumed in the manufacture of product, as well as manufacturing labor, depreciation expense and direct overhead expense necessary to acquire and convert the purchased materials and supplies into finished product. Cost of products sold also includes the cost to distribute products to customers, inbound freight costs, internal transfer costs, warehousing costs and other shipping and handling activity. (d) Inventory turnover = Cost of Goods Sold $38,898 = Average Inventory $6,880 + $8,416 2 = 5.09 or approximately 72 days to turn its inventory, which is a relatively the same as 2008 (5.19 or 70 days).
Its gross profit percentages for 2009 and 2008 are as follows: 2009 $79,029 38,898 $40,131 50.78% 2008 $81,748 39,536 $42,212 51.64%
Net sales................................. Cost of goods sold.............. Gross profit ........................... Gross profit percentage ....
P&G had a small decline in its gross profit and gross profit percentage. Sales in 2009 showed a 3.3% decrease, probably due to an declining economy. It appears that P&G has not been able to manage its costs to maintain gross margin levels on these lower sales.
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9-71
COMPARATIVE ANALYSIS CASE
(a) Coca-Cola reported inventories of $2,354 million, which represents 4.8% of total assets. PepsiCo reported inventories of $2,618 million, which represents 6.6% of its total assets. (b) Coca-Cola determines the cost of its inventories on the basis of average cost or first-in, first-out (FIFO) methods; its inventories are valued at the lower-of-cost-or-market. PepsiCo's inventories are valued at the lower of cost (computed on the average, FIFO or LIFO method) or market. PepsiCo also reported that the cost of 10% of its 2009 inventories was computed using the LIFO method. (c) Coca-Cola classifies and describes its inventories as primarily raw materials and packaging and finished goods. PepsiCo classifies and describes its inventories as (1) raw materials, (2) work-in-process and (3) finished goods. (d) Inventory turnover ratios and days to sell inventory for 2009: Coca-Cola $11,088 = 4.9 times $2,354 + $2,187 2 365 4.9 = 75 days PepsiCo $20,099 = 7.8 times $2,618 + $2,522 2 365 7.8 = 47 days
A substantial difference between Coca-Cola and PepsiCo exists regarding the inventory turnover and related days to sell inventory. The primary reason is that PepsiCo's cost of goods sold and related inventories involves food operations as well as beverage cost. This situation is not true for Coca-Cola. Food will have a much higher turnover ratio because food must be turned over quickly or else spoilage will become a major problem.
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FINANCIAL STATEMENT ANALYSIS CASE 1
(a) Although no absolute rules can be stated, preferability for LIFO can ordinarily be established if (1) selling prices and revenues have been increasing, whereas costs have lagged, to such a degree that an unrealistic earnings picture is presented, and (2) LIFO has been traditional, such as department stores and industries where a fairly constant "base stock" is present such as refining, chemicals, and glass. Conversely, LIFO would probably not be appropriate: (1) where prices tend to lag behind costs; (2) in situations where specific identification is traditional, such as in the sale of automobiles, farm equipment, art, and antique jewelry; and (3) where unit costs tend to decrease as production increases, thereby nullifying the tax benefit that LIFO might provide. Note that where inventory turnover is high, the difference between inventory methods is usually negligible. In this case, it is impossible to determine what conditions exist, but it seems probable that the characteristics of certain parts of the inventory make LIFO desirable, whereas other parts of the inventory provide higher benefits if FIFO is used. (b) It may provide this information (although it is not required to do so) because it believes that this information tells the reader that both its income and inventory would be higher if FIFO had been used. (c) The LIFO liquidation reduces operating costs because low price goods are matched against current revenue. As a result, operating costs are lower than normal because higher operating costs would have normally been deducted from revenues. (d) It would probably have reported more income if it had been on a FIFO basis. For example, its inventory as of December 31, 2012 was stated at $1,635,040. Its inventory under FIFO would have been $364,960 higher (2012) if FIFO had been used. On the other hand, the LIFO liquidation would not have occurred in 2012 or previous years because FIFO would have been used. Thus, the 2012 reduction in operating costs of $24,000 due to the LIFO liquidation would not have occurred.
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9-73
FINANCIAL STATEMENT ANALYSIS CASE 2
(a)
There are probably no finished goods because gold is a highly liquid commodity, and so it can be sold as soon as processing is complete. Ore in stockpiles is a noncurrent asset probably because processing takes more than one year. Sales are recorded as follows: Accounts Receivable or Cash............................... Sales Revenue.................................................... AND Cost of Goods Sold .................................................. Gold in Process Inventory.............................. XXX XXX XXX XXX
(b)
(c)
Balance Sheet Inventory Overstated Retained earnings Overstated Accounts payable No effect Working capital Overstated Current ratio Overstated
Income Statement Cost of goods sold Understated Net income Overstated
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ACCOUNTING, ANALYSIS, AND PRINCIPLES Accounting (a) Residential pumps: Ending inventory cost = (300 X $500) + (200 X $475) = Beginning inventory cost = (200 X $400) = Purchases = $225,000 + $190,000 + $150,000 = Cost of goods sold = $80,000 + $565,000 $245,000 = Commercial pumps: Ending inventory at cost = (500 X $1,000) = Beginning inventory at cost = (600 X $800) = Purchases = $540,000 + $285,000 + $500,000 = Cost of goods sold = $480,000 + $1,325,000 $500,000 = Total ending inventory at cost = $245,000 + $500,000 = Total cost of goods sold = $1,305,000 + $400,000 = Lower-of-cost-or-market:
Residential pumps NRV $580.00 Replacement cost $550.00 Normal Profit Margin 0.1667 X $580.00 = $96.69 NRV normal profit $580.00 $96.69 = margin $483.31 Designated market value $550 Number of unit on hand, 500 Mar. 31 Designated market value $275,000 of ending inventory Required write-down No Commercial pumps $1,050.00 $900.00 0.1667 X $1,050.00 = $175.04 $1,050.00 $175.04 = $874.96 $900 500 $450,000 Yes, $450,000 < $500,000
$ 245,000 $ 80,000 $ 565,000 $ 400,000
$ 500,000 $ 480,000 $1,325,000 $1,305,000 $ 745,000 $1,705,000
Total amount of inventory reported on March 31 balance sheet = $695,000 ($245,000 + $450,000).
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9-75
ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) (b) Inventory at cost = $245,000 + $500,000 = $745,000 Designated market value = $275,000 + $450,000 = $725,000 $725,000 < $745,000, therefore write inventory down to $725,000 Total amount of inventory reported on March 31 balance sheet = $725,000 Analysis In this problem, one product's market value is above cost and the other one is below. From a conservative perspective, the individual product approach results in a write-down for any product whose designated market value is below cost. So, potentially the individual product approach informs the financial statement reader about any products with weak markets, while the category approach does not. One could argue that the company's balance sheet inventory amount, if aggregated into one category, is closer to its market value than with the individual product approach. This approach allows unrealized inventory gains offset inventory losses. It is difficult to say which approach provides better information, but the individual product approach results in a larger write-down. Principles (a) If the designated market value is $1,050, the designated market value of commercial pumps would be above cost. The written-down amount becomes the new cost for that inventory and Englehart would not be allowed to write that inventory back up. The conceptual trade-off inherent in the accounting for inventory as it relates to lower-of-cost-or-market is between relevance and faithful representation. Market is generally thought to be more relevant than cost. Cost is considered less subjective (and a more faithful representation) than market. Under LCM, relevance takes precedence in a down market; however, faithful representation is more important in an up market.
(b)
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PROFESSIONAL RESEARCH
(a)
The codification provides guidance at: FASB ASC 330-10-05 (Codification String: Assets > 330 Inventory > 10 Overall > 05 Background). The primary predecessor literature is: "Restatement and Revision of Accounting Research Bulletins." Accounting Research Bulletin No. 43 (New York: AICPA, 1953), Ch. 4. According to the FASB ASC 330-10-20, the Glossary indicates the following. Inventory is the aggregate of those items of tangible personal property that have any of the following characteristics: a. Held for sale in the ordinary course of business b. In process of production for such sale c. To be currently consumed in the production of goods or services to be available for sale. The term inventory embraces goods awaiting sale (the merchandise of a trading concern and the finished goods of a manufacturer), goods in the course of production (work in process), and goods to be consumed directly or indirectly in production (raw materials and supplies). This definition of inventories excludes long-term assets subject to depreciation accounting, or goods which, when put into use, will be so classified. The fact that a depreciable asset is retired from regular use and held for sale does not indicate that the item should be classified as part of the inventory. Raw materials and supplies purchased for production may be used or consumed for the construction of long-term assets or other purposes not related to production, but the fact that inventory items representing a small portion of the total may not be absorbed ultimately in the production process does not require separate classification. By trade practice, operating materials and supplies of certain types of entities such as oil producers are usually treated as inventory.
(b)
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PROFESSIONAL RESEARCH (Continued) (c) According to the FASB ASC 330-10-20, the Glossary indicates the following for the term Market: As used in the phrase lower-of-cost-or-market, the term market means current replacement cost (by purchase or by reproduction, as the case may be) provided that it meet both of the following conditions: a. Market shall not exceed the net realizable value b. Market shall not be less than net realizable value reduced by an allowance for an approximately normal profit margin. (d) According to FASB ASC 330-10-35: 35-15 Only in exceptional cases may inventories properly be stated above cost. For example, precious metals having a fixed monetary value with no substantial cost of marketing may be stated at such monetary value; any other exceptions must be justifiable by inability to determine appropriate approximate costs, immediate marketability at quoted market price, and the characteristic of unit interchangeability. For: Goods Stated Above Cost 50-3 Where goods are stated above cost this fact shall be fully disclosed.
35-16 It is generally recognized that income accrues only at the time of sale, and that gains may not be anticipated by reflecting assets at their current sales prices. However, exceptions for reflecting assets at selling prices are permissible for both of the following: a. Inventories of gold and silver, when there is an effective government-controlled market at a fixed monetary value b. Inventories representing agricultural, mineral, and other products, with any of the following criteria: (1) Units of which are interchangeable (2) Units of which have an immediate marketability at quoted prices (3) Units for which appropriate costs may be difficult to obtain. Where such inventories are stated at sales prices, they shall be reduced by expenditures to be incurred in disposal.
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PROFESSIONAL SIMULATION
Resources
Journal Entry Cost of Goods Sold ................................................................ Allowance to Reduce Inventory to Market ........... 4,000 4,000
Note: This entry assumes use of the cost-of-goods-sold method.
Explanation Expected selling prices are important in the application of the lower-ofcost-or-market rule because they are used in measuring losses of utility in inventory that otherwise would not be recognized until the period during which the inventory is sold. Declines in replacement cost generally are assumed to foreshadow declines in selling prices expected in the next period and hence in the revenue expected upon the sale of the inventory during the next period. However, the use of current replacement cost as "market" is limited to those situations in which it falls between (1) net realizable value (the "ceiling") and (2) net realizable value less a "normal" profit (the "floor"), both of which depend upon the selling prices expected in the next period for their computation.
Copyright 2011 John Wiley & Sons, Inc.
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IFRS CONCEPTS AND APPLICATION
IFRS9-1 Key similarities are (1) the guidelines on who owns the goods--goods in transit, consigned goods, special sales agreements, and the costs to include in inventory are essentially accounted for the same under IFRS and U.S. GAAP; (2) use of specific identification cost flow assumption, where appropriate; (3) unlike property, plant and equipment, IFRS does not permit the option of valuing inventories at fair value. As indicated above, IFRS requires inventory to be written down, but inventory cannot be written up above its original cost; (4) certain agricultural products and minerals and mineral products can be reported at net realizable value using IFRS. Key differences are related to (1) the LIFO cost flow assumption--GAAP permits the use of LIFO for inventory valuation. IFRS prohibits its use. FIFO and average-cost are the only two acceptable cost flow assumptions permitted under IFRS; (2) lower-of-cost-or-market test for inventory valuation--IFRS defines market as net realizable value. GAAP on the other hand defines market as replacement cost subject to the constraints of net realizable value (the ceiling) and net realizable value less a normal markup (the floor). That is, IFRS does not use a ceiling or a floor to determine market; (3) inventory write-downs--under GAAP, if inventory is written down under the lower-of-cost-or-market valuation, the new basis is now considered its cost. As a result, the inventory may not be written back up to its original cost in a subsequent period. Under IFRS, the write-down may be reversed in a subsequent period up to the amount of the previous writedown. Both the write-down and any subsequent reversal should be reported on the income statement; (4) the requirements for accounting and reporting for inventories are more principles-based under IFRS. That is, GAAP provides more detailed guidelines in inventory accounting.
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Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
(For Instructor Use Only)
IFRS9-2 As shown in the analysis below, under IFRS, LaTour's inventory turnover ratio is computed as follows: Cost of Goods Sold Average Inventory = $578 $154 = 3.75
Difficulties in comparison to a company using GAAP could arise if the U.S. company uses the LIFO cost flow assumption, which is prohibited under IFRS. Generally in times of rising prices, LIFO results in a lower inventory balance reported on the balance sheet (assumes more recently purchased items are sold first). Thus, the GAAP company will report higher inventory turnover ratios. The LIFO reserve can be used to adjust the reported LIFO numbers to FIFO and to permit an "apples to apples" comparison.
IFRS9-3 Reed must not be aware of the important convergence issue arising from the use of the LIFO cost flow assumption; IFRS specifically prohibits its use. Conversely, the LIFO cost flow assumption is widely used in the United States because of its favorable tax advantages. In addition, many argue that LIFO from a financial reporting point of view provides a better matching of current costs against revenue and therefore a more realistic income is computed. The problem is compounded in the United States because LIFO cannot be used for tax purposes unless it is used for financial reporting purposes. As a result, unless the tax law is changed, it is unlikely that GAAP will eliminate the use of the LIFO cost flow assumption because of its substantial tax advantages for many companies. Also, GAAP has more detailed rules related to accounting and reporting of inventories than IFRS. We expect that these more detailed rules will be used internationally because they provide practical guidance for some inventory accounting and reporting issues.
Copyright 2011 John Wiley & Sons, Inc.
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IFRS9-4 (a) Biological assets are measured on initial recognition and at the end of each reporting period at fair value less costs to sell (NRV). Companies record a gain or loss due to changes in the NRV of biological assets in income when it arises. Agricultural produce (which are harvested from biological assets) are measured at fair value less costs to sell (NRV) at the point of harvest. Once harvested, the NRV of the agricultural produce becomes its cost and this asset is accounted for similar to other inventories held for sale in the normal course of business.
(b)
IFRS9-5 (1) (2) (3) (4) (5) $12.80 ($14.80 $1.50 $.50). $16.10. $13.00 ($15.20 $1.65 $.55). $ 9.20 ($10.40 $ .80 $.40). $15.90.
IFRS9-6 Net Realizable Value $80* 62 60 35 70 40
Item D E F G H I
Cost $75 80 80 80 50 36
LCNRV $75 62 60 35 50 36
*Estimated selling price Estimated selling costs and cost to complete = $120 $30 $10 = $80.
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Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
(For Instructor Use Only)
IFRS9-7 (a) 12/31/12 Cost of Goods Sold .................................... Allowance to Reduce Inventory to NRV............................................... Allowance to Reduce Inventory to NRV............................................................. Cost of Goods Sold.......................... Loss Due to Decline of Inventory to NRV...................................... Allowance to Reduce Inventory to NRV ............................................... Allowance to Reduce Inventory to NRV.......................................................... Recovery of Loss Due to Decline of Inventory ..................... 24,000 24,000 4,000* 4,000
12/31/13
(b)
12/31/12
24,000 24,000
12/31/13
4,000* 4,000
*Cost of inventory at 12/31/12 ...................................... Lower-of-cost-or-NRV at 12/31/12............................. Allowance amount needed to reduce Inventory to NRV (a)................................................... Cost of inventory at 12/31/13...................................... Lower-of-cost-or-NRV at 12/31/13............................. Allowance amount needed to reduce Inventory to NRV (b) .................................................. Recovery of previously recognized loss
$346,000 (322,000) $ 24,000 $410,000 (390,000) $ 20,000
= (a) (b) = $24,000 $20,000 = $4,000.
(c)
Both methods of recording lower-of-cost-or-NRV adjustments have the same effect on net income.
Copyright 2011 John Wiley & Sons, Inc.
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IFRS9-8 Biological Assets Shearing Sheep ......................... Unrealized Holding Gain or Loss Income.................................................... *$4,700 $575 = $4,125. IFRS9-9 (a) Wool Inventory.................................................................. Unrealized Holding Gain or Loss Income..................................................... Cash...................................................................................... Cost of Goods Sold ......................................................... Wool Inventory ....................................................... Sales .......................................................................... 9,000 9,000 10,500 9,000 9,000 10,500 4,125* 4,125
(b)
IFRS9-10 (a) The IFRS requirements related to accounting and reporting for inventories is found in IAS 2 (Inventories), IAS 18 (Revenue) and IAS 41 (Agriculture). Inventories are assets: (a) held for sale in the ordinary course of business; (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. (IAS 2, paragraph 6) This Standard applies to all inventories, except: (a) work in progress arising under construction contracts, including directly related service contracts (see IAS 11 Construction Contracts); (b) financial instruments (see IAS 32 Financial Instruments: Presentation and IAS 39 Financial Instruments: Recognition and Measurement); and (c) biological assets related to agricultural activity and agricultural produce at the point of harvest (see IAS 41 Agriculture). (IAS 2, paragraph 2)
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Copyright 2011 John Wiley & Sons, Inc. Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only)
IFRS9-10 (Continued) (c) Net realisable value refers to the net amount that an entity expects to realise from the sale of inventory in the ordinary course of business. Fair value reflects the amount for which the same inventory could be exchanged between knowledgeable and willing buyers and sellers in the marketplace. The former is an entity-specific value; the latter is not. Net realisable value for inventories may not equal fair value less costs to sell. (IAS 2, paragraph 7). This Standard does not apply to the measurement of inventories held by: (a) producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value in accordance with well established practices in those industries. When such inventories are measured at net realisable value, changes in that value are recognised in profit or loss in the period of the change. (b) commodity broker-traders who measure their inventories at fair value less costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognised in profit or loss in the period of the change. (IAS 2, paragraph 3).
(d)
IFRS9-11 (a) Inventories are valued at the lower-of-cost-or-net realisable value using the retail method, which is computed on the basis of selling price less the appropriate trading margin. All inventories are finished goods. Inventories are reported on the statement of financial position simply as "Inventories." The footnotes indicate that all inventories are finished goods. No information is provided in the annual report regarding what costs are included in inventories or cost of sales.
(b)
(c)
Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
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IFRS9-11 (Continued) (d) Inventory turnover = Cost of Sales 5,918.1 = Average Inventory 613.2 + 536.0 2 = 10.30 or approximately 35 days to turn its inventory, which is slightly lower than in 2009 (11.10 or 33 days). Overall, turnover remains high.
Its gross profit percentages for 2010 and 2009 are as follows: 2010 9,536.6 5,918.1 3,618.5 37.94% 2009 9,062.1 5,690.2 3,371.9 37.21%
Net sales ................................. Cost of sales.......................... Gross profit............................ Gross profit percentage.....
M&S had a small improvement in its gross profit and a slight increase in gross profit percentage. Sales in 2010 showed a 5.2% increase, due to (1) inclusion of 53 weeks in 2010 compared to 52 weeks in 2009, and (2) increased UK locations and strong international performance. It appears that M&S has been able to maintain its gross profit percentage on these increased sales.
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Copyright 2011 John Wiley & Sons, Inc.
Kieso, Intermediate Accounting, 14/e, Solutions Manual
(For Instructor Use Only)