ch09_SummaryNotes

ch09_SummaryNotes - CHAPTER 9 Inventories: Additional...

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CHAPTER 9 Inventories: Additional Valuation Issues LEARNING OBJECTIVES 1. Describe and apply the lower-of-cost-or-market rule. 2. Explain when companies value inventories at net realizable value. 3. Explain when companies use the relative sales value method to value inventories. 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. *8. Determine ending inventory by applying the LIFO retail methods. *This material is covered in an Appendix to the chapter. The struck-through material will not be covered. CHAPTER REVIEW *Note: All asterisked (*) items relate to material contained in the Appendix to the chapter. 1. Chapter 9 concludes the discussion of inventories by addressing certain unique valuation problems not covered in Chapter 8. Chapter 9 also includes a description of the devel- opment and use of various estimation techniques used to value ending inventory without a physical count. Lower of Cost or Market 2. (L.O. 1) When the future revenue-producing ability associated with inventory is below its original cost, the inventory should be written down to reflect this loss. Thus, the historical cost principle is abandoned when the future utility of the asset is no longer as great as its original cost. This is known as the lower-of-cost-or-market (LCM) method of valuing inventory and is an accepted accounting practice. When inventory declines in value below its original cost, the inventory should be written down to reflect the loss. This loss of utility in inventory should be charged against revenue in the period in which the loss occurs. 3. The term “market” in lower of cost or market generally refers to the replacement cost of an inventory item. However, market value should not exceed net realizable value (NRV), nor should it be less than net realizable value less a normal markup. These are known as the upper (ceiling) and lower (floor) limits of market, respectively. Market is defined as replacement cost if such cost falls between the upper and lower limits. Should replacement cost be above the upper limit, market would be defined as net realizable value. If replacement cost falls below the lower limit, market is defined as net realizable value less a normal markup.
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4. For example, consider the following illustration. Inventory at sales value. ............................... $800 Less: Cost to complete and sell. ................. 200 Net realizable value (NRV). .......................... 600 Less: Normal markup. ................................. 100 NRV less normal markup. ............................ $500 To arrive at the final inventory valuation, market value must be determined and then compared to cost. Market value is determined by comparing replacement cost of the inventory with the upper and lower limits. If replacement cost of the inventory in the
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ch09_SummaryNotes - CHAPTER 9 Inventories: Additional...

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