Lecture%204-5%20PII_std-2

Lecture%204-5%20PII_std-2 - Inventories Week 4-5 Part II 2...

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Unformatted text preview: Inventories Week 4-5 Part II 2 1. Understand the lower of cost or market method. 2. Understand purchase obligations and product financing arrangements. 3. Estimate cost of ending inventory: gross profit method and retail inventory method. 4. Understand the effects of inventory errors on the financial statements. Objectives 1. Lower of cost and market: Concept The lower of cost or market (LCM) rule requires that a company recognize a decline in the inventory's utility as a loss of the period, and that the company write down its ending inventory to the market value. This rule is consistent with the conservatism convention. Concepts – Market value is defined as the current replacement cost of inventory (not the current selling price) by purchase or manufacture, with upper and lower constraints imposed. – Ceiling constraint: The market value cannot be greater than the net realizable value (estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal). – Floor constraint: The market value cannot be less than the net realizable value reduced by a normal profit margin (normal markup). 3 4 Lower of Cost or Market Inventory: Estimated selling price in completed condition $1,150 Less: Estimated costs to complete and sell 150 Net realizable value (ceiling) $1,000 Less: normal profit 100 NRV less normal profit (floor) $ 900 Inventory: Estimated selling price in completed condition $1,150 Less: Estimated costs to complete and sell 150 Net realizable value (ceiling) $1,000 Less: normal profit 100 NRV less normal profit (floor) $ 900 Continued Continued Continued Continued 5 Lower of Cost or Market 6 A company’s unit of inventory has the following characteristics: Selling price $165 Packaging cost 10 Transportation cost 15 Profit margin 40 A company’s unit of inventory has the following characteristics: Selling price $165 Packaging cost 10 Transportation cost 15 Profit margin 40 Lower of Cost or Market : Example 7 Selling price $165 Cost of completion (10) Transportation cost (15 ) Ceiling (NRV) $140 Normal Profit = $40 Normal Profit = $40 Case 1 Case 1 Ceiling $140 Normal profit (40 ) Floor $100 8 Current Replacement Cost = $120 Cost = $110 Normal Profit = $40 Normal Profit = $40 Case 1 Case 1 Selling price $165 Cost of completion (10) Transportation cost (15 ) Ceiling (NRV) $140 Ceiling $140 Normal profit (40 ) Floor $100 9 Current Replacement Cost = $150 Cost = $110 What is market? Case 2 Case 2 Normal Profit = $40 Normal Profit = $40 Selling price $165 Cost of completion (10) Transportation cost (15 ) Ceiling (NRV) $140 Ceiling $140 Normal profit (40 ) Floor $100 10 Cost = $110 What is market?...
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This note was uploaded on 02/04/2012 for the course ACCT 3111 taught by Professor Zhang during the Spring '11 term at CUHK.

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Lecture%204-5%20PII_std-2 - Inventories Week 4-5 Part II 2...

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