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Unformatted text preview: Chapter 09 - Inventories: Additional Issues Question 9-1 Question 9-2 Question 9-3 Question 9-4 Question 9-5 The gross profit method estimates cost of goods sold, which is then subtracted from cost of goods available for sale to obtain an estimate of ending inventory. The estimate of cost of goods sold is found by multiplying sales by the historical ratio of cost to selling prices. The cost percentage is the reciprocal of the gross profit ratio. 9-1 Chapter 9 Inventories: Additional Issues QUESTIONS FOR REVIEW OF KEY TOPICS GAAP generally require the use of historical cost to value assets, but a departure from cost is necessary when the utility of an asset is no longer as great as its cost. The utility or benefits from inventory result from the ultimate sale of the goods. This utility could be reduced below cost due to deterioration, obsolescence, or changes in price levels. To avoid reporting inventory at an amount greater than the benefits it can provide, the lower-of-cost-or-market approach to valuing inventory was developed. This approach results in the recognition of losses when the value of inventory declines below its cost, rather than in the period in which the goods are ultimately sold. The designated market value in the LCM rule is the middle number of replacement cost (RC), net realizable value (NRV) and net realizable value less a normal profit margin (NRV-NP). This is the amount compared with cost to determine LCM. The LCM determination can be made based on individual inventory items, on logical categories of inventory, or on the entire inventory. The preferred method is to record the loss from the write-down of inventory as a separate item in the income statement rather than including the write-down in cost of goods sold. A less desirable alternative is to include the loss in cost of goods sold. Chapter 09 - Inventories: Additional Issues Question 9-6 The key to obtaining accurate estimates when using the gross profit method is the reliability of the cost percentage. If the cost percentage is too low, cost of goods sold will be understated and ending inventory overstated. Cost percentages usually are based on relationships of past years, which arent necessarily representative of the current relationship. Failure to consider theft or spoilage also could cause an overstatement of ending inventory. Answers to Questions (continued) Question 9-7 The retail inventory method first determines the amount of ending inventory at retail by subtracting sales for the period from goods available for sale at retail . Ending inventory at retail is then converted to cost by multiplying it by the cost-to-retail percentage. Question 9-8 The main difference between the gross profit method and the retail inventory method is in the determination of the cost percentage used to convert sales at selling prices to sales at cost. The retail inventory method uses a cost percentage, called the cost-to-retail percentage, which is based on a current relationship between cost and selling price. relationship between cost and selling price....
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- Spring '11