HIGHLIGHTS OF CHAPTER 9:HIGHLIGHTS OF CHAPTER 9: Additional Issues Additional Issues

March 2004March 2004

SIGNIFICANT ISSUESSIGNIFICANT ISSUESLower of cost or market Lower of cost or market Gross profit methodGross profit methodRetail methodRetail methodDollar-value retail methodDollar-value retail methodChange in inventory methodChange in inventory methodCorrection of errorCorrection of errorPurchase commitmentsPurchase commitments

LOWER OF COST OR LOWER OF COST OR MARKETMARKET

Principle of conservatismPrinciple of conservatismReplacement cost v NRV Replacement cost v NRV Applying floor & ceilingApplying floor & ceilingDesignated market value v CostDesignated market value v Cost3 application approaches3 application approaches

FLOOR & CEILINGFLOOR & CEILING

Ceiling - Net Realizable ValueCeiling - Net Realizable ValueReplacement costReplacement costFloor - NRV less normal profitFloor - NRV less normal profit

APPLYING RULEAPPLYING RULECeiling:Ceiling:

Sales price Sales price 1,200 1,200

Cost to complete Cost to complete 100100

NRVNRV 1,100 1,100

Floor:Floor:

NRV NRV 1,100 1,100

Normal profit Normal profit 120120

NRV less profit NRV less profit 980980

APPLYING RULEAPPLYING RULECostCost 1,000 1,000

Ceiling - NRVCeiling - NRV 1,100 1,100

Replacement costReplacement cost 950 950

Floor - NRV less profit 980Floor - NRV less profit 980

Designated market valueDesignated market value 980 980

ALWAYS CHOOSE THE VALUE IN ALWAYS CHOOSE THE VALUE IN THE MIDDLETHE MIDDLE

THREE APPROACHESTHREE APPROACHES

Item by itemItem by itemBy groupBy groupEntire inventoryEntire inventory

GROSS PROFIT METHODGROSS PROFIT METHOD

Estimate ending inventoryEstimate ending inventoryBased on normal gross profitsBased on normal gross profitsOnly an estimate!Only an estimate!

GROSS PROFIT METHODGROSS PROFIT METHODBeginning inventory (at cost) Beginning inventory (at cost) $60,000$60,000

Purchases (at cost)Purchases (at cost) 200,000200,000

Total goods available for sale 260,000Total goods available for sale 260,000

Sales (at selling price) $280,000Sales (at selling price) $280,000

Less: Gross profit at 30% Less: Gross profit at 30% 84,00084,000

Sales (at cost)Sales (at cost) 196,000196,000

Estimated inventory (at cost) $64,000 Estimated inventory (at cost) $64,000

GROSS PROFIT RATIOGROSS PROFIT RATIO% of sales% of salesAlternative is markup on costAlternative is markup on cost

-Stated as % of cost-Stated as % of costCost Cost $100$100

Gross profit Gross profit 50 50Markup on cost Markup on cost 50% 50%

RETAIL METHODRETAIL METHODCOSTCOST

RETAILRETAIL

Beginning inventory Beginning inventory $1,000$1,000 $1,800$1,800

Purchases Purchases 30,00030,000 60,00060,000

Freight-in 600Freight-in 600 - -

Purchase returns (1,500) (3,000)Purchase returns (1,500) (3,000)

Net mark-ups 9,000Net mark-ups 9,000

Abnormal shortages Abnormal shortages (1,200)(1,200) (2,000)(2,000)

TotalTotal $28,900 $65,800 $28,900 $65,800

Cost-to-retail % = 28900/65800 = 43.9%Cost-to-retail % = 28900/65800 = 43.9%

RETAIL METHODRETAIL METHOD RETAILRETAIL

Total available for sale at retailTotal available for sale at retail $65,800$65,800

Less: Net markdownsLess: Net markdowns 1,400 1,400

SalesSales $36,000 $36,000

Sales returns Sales returns (900)(900) 35,100 35,100

Employee discounts Employee discounts 800 800

Normal shortages Normal shortages 1,300 1,300

Ending inventory at retailEnding inventory at retail $27,200 $27,200

Cost-to-retail % 43.9%Cost-to-retail % 43.9%

Ending inventory at costEnding inventory at cost $11,941 $11,941

LIFO RETAIL METHODLIFO RETAIL METHODCOSTCOST

RETAILRETAIL

Beginning inventory 2001 Beginning inventory 2001 $27,000$27,000 $45,000$45,000

Purchases, netPurchases, net 346,500 346,500 480,000480,000

Net mark-ups 20,000Net mark-ups 20,000

Net mark-downs Net mark-downs _______ _______ ( 5,000)( 5,000)

Total Total $346,500 $495,000 $346,500 $495,000

Net salesNet sales 484,000484,000

Ending inventory 2001 at retail $ 56,000Ending inventory 2001 at retail $ 56,000

2001 Cost-to-retail % (346,500/495,000) 2001 Cost-to-retail % (346,500/495,000) 70.0%70.0%

LIFO RETAIL METHODLIFO RETAIL METHODEnding inventory 2001 at retail $ 56,000 Ending inventory 2001 at retail $ 56,000

Cost-to-Cost-to- LIFOLIFO

Layer Layer RetailRetail retail % retail % Cost__ Cost__

20002000 $45,000 $45,000 60% 60% $27,000$27,000

20012001 11,00011,000 70% 70% _ 7,700_ 7,700

$56,000$56,000 $34,700$34,700

DOLLAR-VALUE LIFODOLLAR-VALUE LIFOCOSTCOST

RETAILRETAIL

Beginning inventory 2001 Beginning inventory 2001 $27,000$27,000 $45,000$45,000

Purchases, netPurchases, net 346,500 346,500 480,000480,000

Net mark-ups 20,000Net mark-ups 20,000

Net mark-downs Net mark-downs _______ _______ ( 5,000)( 5,000)

Total Total $346,500 $495,000 $346,500 $495,000

Net salesNet sales 484,000484,000

Ending inventory 2001 at retail $ 56,000Ending inventory 2001 at retail $ 56,000

2001 Cost-to-retail % (346,500/495,000) 2001 Cost-to-retail % (346,500/495,000) 70.0%70.0%

DOLLAR-VALUE LIFODOLLAR-VALUE LIFOEnding inventory 2001 at retail $ 56,000 Ending inventory 2001 at retail $ 56,000

Price indexes:Price indexes:

20002000 100%100%

20012001 112%112%

Ending inventory 2001 at retail deflated to base-Ending inventory 2001 at retail deflated to base-year prices (56,000 /112%) $ 50,000 year prices (56,000 /112%) $ 50,000

DOLLAR-VALUE LIFODOLLAR-VALUE LIFOEnding inventory 2001 at retail $ 56,000 Ending inventory 2001 at retail $ 56,000

Ending inventory 2001 at base-year $ 50,000Ending inventory 2001 at base-year $ 50,000

Beginning inventory 2001 at base-year Beginning inventory 2001 at base-year 45,00045,000

Inventory increase at base-year prices 5,000Inventory increase at base-year prices 5,000

Price Cost-to-Price Cost-to- LIFO LIFO

Layer Layer Retail Retail IndexIndex retail % retail % Cost__ Cost__

20002000 $45,000 100% $45,000 100% 60% 60% $27,000$27,000

20012001 5,0005,000 112% 112% 70% 70% _ 3,920_ 3,920

$50,000$50,000 $30,920 $30,920

DOLLAR-VALUE LIFODOLLAR-VALUE LIFOEnding inventory 2002 at retail $ 64,800 Ending inventory 2002 at retail $ 64,800

Ending inventory 2002 at base-year $ 54,000Ending inventory 2002 at base-year $ 54,000

Beginning inventory 2002 at base-year Beginning inventory 2002 at base-year 50,00050,000

Inventory increase at base-year prices 4,000Inventory increase at base-year prices 4,000

Price Cost-to-Price Cost-to- LIFO LIFO

Layer Layer Retail Retail IndexIndex retail % retail % Cost__Cost__

20002000 $45,000 100% $45,000 100% 60% 60% $27,000$27,000

20012001 5,000 112% 5,000 112% 70% 70% 3,920 3,920

20022002 4,0004,000 120% 120% 75% 75% _ 3,600_ 3,600

$54,000$54,000 $34,520 $34,520

CHANGE IN METHODCHANGE IN METHODCumulative effect on prior Cumulative effect on prior

years included in current P/Lyears included in current P/LChange to LIFO reported on Change to LIFO reported on

prospective basisprospective basisChange from LIFO reported Change from LIFO reported

on retroactive basis by on retroactive basis by restating prior year statementsrestating prior year statements

CORRECTION OF ERRORCORRECTION OF ERROR

Restating prior year statementsRestating prior year statementsRecord adjustmentsRecord adjustments

EFFECT OF INVENTORY ERRORSEFFECT OF INVENTORY ERRORS

Beginning inventoryBeginning inventoryEnding inventoryEnding inventoryPurchases Purchases Cost of goods soldCost of goods soldRetained earningsRetained earningsFollowing yearsFollowing years

PURCHASE COMMITMENTSPURCHASE COMMITMENTS

Record loss when price Record loss when price declines – not when solddeclines – not when sold

Record purchase at market Record purchase at market valuevalue

Loss on future purchases Loss on future purchases creates a future estimated creates a future estimated liabilityliability