inventory valuation at other than cost
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Inventory Inventory Valuation at Valuation at Other Than Other Than
CostCost
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Apply the lower-of-cost-or-market (LCM) rule to reflect declines in the market value of inventory.
Use the gross profit method to estimate ending inventory.
Compute estimates of FIFO, LIFO, average cost, and lower-of-cost-or-market inventory using the retail inventory method.
Learning Objectives
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Determine the financial statement impact of inventory recording errors.
Learning Objectives
EXPANDED MATERIAL Combine the retail inventory method and
dollar-value LIFO to compute ending inventory using the dollar-value LIFO retail method.
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Learning Objectives Account for the impact of changing prices
on purchase commitments. Record inventory purchase transactions
denominated in foreign currencies.
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Inventory Estimation Methods
Lower-of-Cost-or-Market Method Gross Profit Method Retail Inventory Method Dollar-Value LIFO Retail Method
Methods for valuing inventory at Methods for valuing inventory at other than costother than cost
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Lower of Cost or Market (LCM)
What is market?
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Lower of Cost or Market (LCM)In lower of cost or
market, market means replacement cost within limits.
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• When goods remaining in inventory can be replaced with identical goods at a lower cost, the lower (market) cost must be used to value the inventory.
• What are the replacement cost limits?– Upper limit: Net realizable value.– Lower limit: Net realizable value minus a
normal profit.
Lower of Cost or Market (LCM)
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A company’s unit of inventory A company’s unit of inventory has the following has the following characteristics:characteristics:
Selling priceSelling price $165$165Packaging costPackaging cost 1010Transportation costTransportation cost 1515Profit marginProfit margin 4040
LCM Examples
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Selling priceSelling price $165 $165 Cost of completionCost of completion (10)(10)Transportation costTransportation cost (15 (15))Ceiling (NRV)Ceiling (NRV) $140 $140
Ceiling (NRV)Ceiling (NRV) $140 $140 Normal profitNormal profit (40(40))FloorFloor $100 $100
Normal Profit = $40Normal Profit = $40
LCM Examples
Net Net realizable realizable
valuevalueExample
1
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Current Replacement Cost, $150
Cost $155
Market $140
Normal Profit = $40
LCM is LCM is market, market,
$140$140
LCM Examples
Ceiling (NRV)Ceiling (NRV) $140 $140 Normal profitNormal profit (40(40))FloorFloor $100 $100
Selling priceSelling price $165 $165 Cost of completionCost of completion (10)(10)Transportation costTransportation cost (15 (15))Ceiling (NRV)Ceiling (NRV) $140 $140
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Cost $110
LCM is LCM is cost, $110cost, $110
Market $120
Current Replacement Cost, $120
Normal Profit = $40Normal Profit = $40
LCM Examples
Example 2
Selling priceSelling price $165 $165 Cost of completionCost of completion (10)(10)Transportation costTransportation cost (15 (15))Ceiling (NRV)Ceiling (NRV) $140 $140
Ceiling (NRV)Ceiling (NRV) $140 $140 Normal profitNormal profit (40(40))FloorFloor $100 $100
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Current Replacement
Cost, $75
Cost $110
LCM is LCM is market, market,
$100$100
Market $100
LCM Example
Example 3
Selling priceSelling price $165 $165 Cost of completionCost of completion (10)(10)Transportation costTransportation cost (15 (15))Ceiling (NRV)Ceiling (NRV) $140 $140
Normal Profit = $20Normal Profit = $20
Ceiling (NRV)Ceiling (NRV) $140 $140 Normal profitNormal profit (40(40))FloorFloor $100 $100
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Recording LCM Revaluations
LCM may be applied to each individual inventory item or to the inventory as a whole.
If LCM is applied to individual items, the difference between cost and market is credited directly to Inventory.
If LCM is applied to the inventory as a whole, the difference is recorded in an allowance account.
15LCM--Example: Recording Revaluation (data for valuation)
A 20 $10 $200 $11 $200 $220B 10 $10 $100 $9 $90 $90C 10 $10 $100 $8 $80 $80D 20 $10 $200 $9 $180 $180
$600 $550 $570
Original CostItem Qty Market
IndLCM
MktLCM
Total Cost
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Journal EntryLoss from Decline in Value of Inventory..... 50
Inventory............................................ 50
LCM--Example: Recording Revaluation (applied individually)
A 20 $10 $200 $11 $200 $220B 10 $10 $100 $9 $90 $90C 10 $10 $100 $8 $80 $80D 20 $10 $200 $9 $180 $180
$600 $550 $570$50
Original CostItem Qty Market
IndLCM
MktLCM
Total Cost
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A 20 $10 $200 $11 $200 $220B 10 $10 $100 $9 $90 $90C 10 $10 $100 $8 $80 $80D 20 $10 $200 $9 $180 $180
$600 $550 $570
LCM--Example: Recording Revaluation (applied as a whole)
Journal EntryLoss from Decline in Value of Inventory.............. 30 Allowance for Decline in Value of Inventory.. 30
$30
Original CostItem Qty Market
IndLCM
MktLCM
Total Cost
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Gross Profit Method
The gross profit method is an estimation technique to
determine the inventory count...
when a physical count is not practical, and
as a validity check.
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Gross Profit Method Steps
Determine gross profit percentage.Determine estimated sales.Determine estimated cost of goods
sold.Determine estimated goods available
for sale.Determine estimated inventory.
20Gross Profit Method--Example: Basic Data
Use the following information to estimate ending inventory:
• Gross Profit Percentage 50% of sales• Accounts Receivable Collections $ 5,000• Ending Accounts Receivable $ 1,000• Beginning Accounts Receivable $ 2,000• Beginning Inventory $ 6,000• Payments to Suppliers $ 10,000• Ending Accounts Payable $ 3,000• Beginning Accounts Payable $ 1,000
21Gross Profit Method--Solution
Given as 50%, and management does not feel any changes are warranted.
Step No.1Determine Gross Profit Percentage
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Step No.2Determine Estimated Sales
Accounts receivable collections $ 5,000 Add ending accounts receivable 1,000
$ 6,000 Deduct beginning accounts receivables (2,000)Estimated sales $ 4,000
Gross Profit Method--Solution
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Estimated sales $ 4,000 Times gross profit percentage x 50% Estimated cost of goods sold $ 2,000
Step No. 3Determine Estimated Cost of Goods Sold
Gross Profit Method--Solution
24Gross Profit Method--Solution
Step No. 4 Determine Estimated
Goods Available for SaleBeginning inventory $ 6,000Add payments to suppliers $10,000 Add ending accounts payable 3,000
$13,000 Deduct beginning accts. pay. (1,000)Estimated purchases 12,000Estimated goods available for sale $18,000
25Gross Profit Method--Solution
Step No.5Determine Estimated Inventory
Estimated goods available for sale $18,000Estimated cost of goods sold 2,000Estimated inventory $16,000
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Estimated Cost of Goods Sold
Gross Profit Method
Estimated Cost of Goods Sold
Estimated Gross Profit
Sales
Estimated Ending
Inventory
Cost of Goods Available for
Sale
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Salad Oil Swindle
Tino DeAngelis rented a petroleum tank farm in Bayonne, New Jersey.
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Salad Oil Swindle
He convinced auditors, investors, and investment bankers that the tanks
contained $100 million in vegetable oil.
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Salad Oil Swindle
The tanks actually were primarily filled with sea water. There was very little
vegetable oil in the tanks.
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Salad Oil Swindle
Tino would pump vegetable oil from one tank to another, depending on his advance
knowledge of the auditor’s verification plan.
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Retail Inventory Method
1. Determine goods available for sale at cost and retail.
2. Determine cost percentage.3. Determine ending inventory at retail.4. Determine ending inventory at cost.
32Retail Inventory Method--Different Cost Methods
Lower-of-Cost-or-MarketLower-of-Cost-or-Market Approximation: Approximation: Markups Markups but but not markdownsnot markdowns are included in are included in
the calculation of goods the calculation of goods available for sale.available for sale.Average Cost Method: Markups and markdowns
are included in calculation of goods
available for sale.
33Retail Inventory Method-- Example
Use the following information to estimate ending inventory: Cost RetailBeginning inventory $1,000$2,000Purchases 5,000 8,000Markups 2,000Sales 6,000Markdowns 600
34Retail Inventory Method--Solution for LCM Approximation
Step No.1Determine Goods Available for Sale at Cost and Retail--LCM
Approximation
Cost Retail Beginning inventory $1,000 $ 2,000Purchases 5,000 8,000Markups 2,000Goods available for sale $6,000 $12,000
35Retail Inventory Method--Solution for LCM Approximation
Step No. 2Determine Cost Percentage
Goods available for sale at cost $ 6,000Divided by goods available for
sale 12,000Cost percentage 50%
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Step No.3Determine Ending Inventory at Retail
Retail Inventory Method--Solution for LCM Approximation
Goods available for sale $12,000 Less sales (6,000)Less markdowns (600)Ending inventory at retail $ 5,400
37Retail Inventory Method--Solution for LCM Approximation
Ending Inventory at Retail $5,400 Times Cost Percentage x 50%Ending Inventory at Cost $2,700
Step No.4Determine Ending Inventory at Cost
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Step No.1Determine Goods Available for Sale
Retail Inventory Method--Solution for Average Cost Method
Cost Retail Beginning inventory $1,000 $ 2,000 Purchases 5,000 8,000 Markups 2,000 Markdowns (600)Goods available for sale $6,000 $11,400
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Goods available for sale at cost $ 6,000Divided by goods available for
sale at retail 11,400Cost percentage 52.6%
Retail Inventory Method--Solution for Average Cost Method
Step No. 2Determine Cost Percentage
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Step No. 3Determine Ending Inventory at Retail
Retail Inventory Method--Solution for Average Cost Method
Goods available for sale $11,400 Less sales (6,000)Less markdowns (600)Ending inventory at retail $ 4,800
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Step No.4Determine Ending Inventory at Cost
Retail Inventory Method--Solution for Average Cost Method
Ending inventory at retail $4,800 Times cost percentage x 52.6%Ending inventory at cost $2,525
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Retail Inventory Method
Beginning Inventory
+Purchases= Goods Available for Sale
Goods Available for
Sale: At Retail
Estimated Ending
Inventory at Retail
Less Sales
ContinuedContinued
To calculation of cost percentage
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Retail Inventory Method
Beginning Inventory
+Purchases= Goods Available for Sale
Goods Available for Sale: At Cost
ContinuedContinued
To calculation of cost percentage
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Retail Inventory Method
Cost Percentage:Cost/Retail
x Cost Percentage
Estimated Ending Inventory at Retail
Estimated Ending Inventory at Cost
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Freight-in is added to the cost of purchases.Purchase discounts are subtracted from the cost of
purchases.Purchase returns are subtracted from both the cost
and retail amount of purchases.Purchase allowances normally are subtracted only
from the cost of purchases.Sales returns are subtracted from retail sales.Sales discounts and sales allowances are not
subtracted from retail sales.
Retail Inventory Method
46Dollar-Value LIFO Retail Inventory Method Steps
1. Determine inventory at base-year retail prices.
2. Determine dollar-value LIFO inventory layers at retail.
3. Determine dollar-value LIFO inventory layers at cost.
47Dollar-Value LIFO RetailInventory Method--Example
Use the following data to estimate Ending Inventory for 2000, 2001, and 2002 (assume 1999 is the base year).
Inventory at Year-End Incremental Year-End
Year Price Index Cost Percentage Retail Prices1999 1.00 .60 $602000 1.05 .62 $692001 1.10 .64 $772002 1.12 .65 $71
48Dollar-Value LIFO RetailInventory Method--Example
Dollar- Inv @ Value
Inv @ Base- Incr. Incr. LIFOEoY Price Year Layer Cost Retail
Year Retail Index Retail Layers Index % Cost
1999 $60 ÷ 1.00 = $60
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Dollar- Inv @ Value
Inv @ Base- Incr. Incr. LIFOEoY Price Year Layer Cost Retail
Year Retail Index Retail Layers Index % Cost
1999 $60 ÷ 1.00 = $60 $60 x 1.00 x 0.60 = $36
Dollar-Value LIFO RetailInventory Method--Example
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Dollar- Inv @ Value
Inv @ Base- Incr. Incr. LIFOEoY Price Year Layer Cost Retail
Year Retail Index Retail Layers Index % Cost
1999 $60 ÷ 1.00 = $60 $60 x 1.00 x 0.60 = $362000 $69 ÷ 1.05 = $66
Dollar-Value LIFO RetailInventory Method--Example
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Dollar- Inv @ Value
Inv @ Base- Incr. Incr. LIFOEoY Price Year Layer Cost Retail
Year Retail Index Retail Layers Index % Cost
1999 $60 ÷ 1.00 = $60 $60 x 1.00 x 0.60 = $362000 $69 ÷ 1.05 = $66 $60 x 1.00 x 0.60 = $36
6 x 1.05 x 0.62 = 4$66 $40
Dollar-Value LIFO RetailInventory Method--Example
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Dollar- Inv @ Value
Inv @ Base- Incr. Incr. LIFOEoY Price Year Layer Cost Retail
Year Retail Index Retail Layers Index % Cost
1999 $60 ÷ 1.00 = $60 $60 x 1.00 x 0.60 = $362000 $69 ÷ 1.05 = $66 $60 x 1.00 x 0.60 = $36
6 x 1.05 x 0.62 = 4$66 $40
2001 $77 ÷ 1.10 = $70
Dollar-Value LIFO RetailInventory Method--Example
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Dollar- Inv @ Value
Inv @ Base- Incr. Incr. LIFOEoY Price Year Layer Cost Retail
Year Retail Index Retail Layers Index % Cost
1999 $60 ÷ 1.00 = $60 $60 x 1.00 x 0.60 = $362000 $69 ÷ 1.05 = $66 $60 x 1.00 x 0.60 = $36
6 x 1.05 x 0.62 = 4$66 $40
2001 $77 ÷ 1.10 = $70 $60 x 1.00 x 0.60 = $366 x 1.05 x 0.62 = 4
4 x 1.10 x 0.64 = 3$70 $43
Dollar-Value LIFO RetailInventory Method--Example
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Dollar- Inv @ Value
Inv @ Base- Incr. Incr. LIFOEoY Price Year Layer Cost Retail
Year Retail Index Retail Layers Index % Cost
2001 $77 ÷ 1.10 = $70 $60 x 1.00 x 0.60 = $366 x 1.05 x 0.62 = 4
4 x 1.10 x 0.64 = 3$70 $43
2002 $71 ÷ 1.12 = $63
Dollar-Value LIFO RetailInventory Method--Example
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Dollar- Inv @ Value
Inv @ Base- Incr. Incr. LIFOEoY Price Year Layer Cost Retail
Year Retail Index Retail Layers Index % Cost
2001 $77 ÷ 1.10 = $70 $60 x 1.00 x 0.60 = $366 x 1.05 x 0.62 = 4
4 x 1.10 x 0.64 = 3$70 $43
2002 $71 ÷ 1.12 = $63 $60 x 1.00 x 0.60 = $36 3 x 1.05 x 0.62 = 2
$63 $38
Dollar-Value LIFO RetailInventory Method--Example
56Foreign Currency Transactions--Terminology
• Foreign Currency Transaction: For a U.S. company, a transaction denominated in a currency other than the U.S. dollar.
• Spot Rate: The exchange rate at which currencies can be traded immediately.
57Foreign Currency Transactions--Example: Scenario
On March 1, Able, a U.S. company, buys inventory worth 1 million DM from Kraus, a German company. Payment is due on April 30. Able closes its books every month. Using the following exchange rates, prepare all necessary journal entries:March 1 Rate: $.58/DMMarch 31 Rate: $.60/DMApril 30 Rate: $.59/DM
58Foreign Currency Transactions--Example: Solution
March 1Inventory..................... 580,000
Accounts Payable....580,000Calculation:DM payable 1,000,000Exchange rate x .58Accounts payable $ 580,000
59Foreign Currency Transactions--Example: Solution
March 31Exchange Loss................ 20,000
Accounts Payable......... 20,000Calculations:
Accounts payable (3/1) $580,000Accounts payable (3/31)
($1,000,000 x 0.60) 600,000Exchange loss $ 20,000
60Foreign Currency Transactions--Example: Solution
April 30Accounts Payable............... 600,000
Exchange Gain................ 10,000Cash................................ 590,000
Calculations:Accounts payable (3/31) $600,000Cash ($1,000,000 x 0.59) 590,000Foreign exchange gain $ 10,000
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The End
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