ch09 - Chapter 9: Inventories: Additional Valuation Issues...

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  Chapter 9 1 Chapter 9: Inventories: Additional    Valuation Issues AIM 3331-0U1 Summer 2009 Xinyi Lu
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  Chapter 9 2 Objective 1. Explain the lower-of-cost-or-market rule. 2. Explain inventories valuation at net realizable value. 3. Explain inventories valuation using relative sales  value. 4. Discuss accounting issues related to purchase  commitments. 5. Determine ending inventory by applying the gross  profit method. 6. Determine ending inventory by applying the retail  inventory method. 7. Explain how to report and analyze inventory.
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  Chapter 9 3 Lower-of-Cost-or-Market (LCM) Generally, GAAP requires that companies account  for and report most assets and liabilities on the basis  of acquisition price ( The historical cost principle ).  However, when the  future revenue-producing  ability  associated with inventory is below its  original  cost,  the inventory should be written down to reflect  this loss.  The lower of cost or market is an  exception  to the  historical cost principle. 
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  Chapter 9 4 Lower-of-Cost-or-Market (cont.) Cost ” is the acquisition price of inventory computed  using one of the historical cost-based method (e.g.  specific identification, average cost, FIFO, or LIFO). Market ” refers to the replacement cost of an  inventory item.  LCM means companies value inventory at  historical  cost or cost to replace, whichever is lower . Loss should be recorded when loss occurs, not in the  period of sale.
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  Chapter 9 5 Lower-of-Cost-or-Market Rule The general LCM rule is:  A company values inventory at the  lower-of-cost-or-market, with market  limited to an amount that is not more  than net realizable value or less than  realizable value less a normal profit  margin. 
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  Chapter 9 6 Designated Market Value The rule implies that the market value (replacement  cost)  should not exceed the “ceiling” and “floor”   limits of market value. The  upper (ceiling)  is the net realizable value  (NRV).  Net realizable value  (NRV) is the estimated selling  price less reasonably predictable cost of completion  and disposal. The  lower (floor)  is net realizable value less a normal  profit margin.  These limits are used to prevent companies from over-  or understating inventory.
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  Chapter 9 7 Designated Market Value (cont.) The amount that is compared to cost is  referred to as  designated market value. Designated market value   is always the  middle  value  of the three amounts: replacement cost,  net realizable value, and net realizable value  less a normal profit margin.
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  Chapter 9 8 Steps of LCM Valuation Step 1: To determine the historical “cost” 
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This note was uploaded on 08/06/2009 for the course BUSINESS 4444 taught by Professor Dr.dale during the Spring '09 term at University of Texas at Dallas, Richardson.

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ch09 - Chapter 9: Inventories: Additional Valuation Issues...

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