inventory valuation at other than cost

Inventory Inventory Valuation at Valuation at Other Than Other Than

CostCost

2

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

3

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.

4

Learning Objectives Account for the impact of changing prices

on purchase commitments. Record inventory purchase transactions

denominated in foreign currencies.

5

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

6

Lower of Cost or Market (LCM)

What is market?

7

Lower of Cost or Market (LCM)In lower of cost or

market, market means replacement cost within limits.

8

• 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)

9

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

10

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

11

Current Replacement Cost, $150

Cost $155

Market $140

Normal Profit = $40

LCM is LCM is market, market,

$140$140

LCM Examples



12

Cost $110

LCM is LCM is cost, $110cost, $110

Market $120

Current Replacement Cost, $120


LCM Examples

Example 2



13

Current Replacement

Cost, $75

Cost $110

LCM is LCM is market, market,

$100$100

Market $100

LCM Example

Example 3




14

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

16

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


IndLCM

MktLCM

Total Cost

17

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


IndLCM

MktLCM

Total Cost

18

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.

19

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

22

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

23

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


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


Step No.5Determine Estimated Inventory

Estimated goods available for sale $18,000Estimated cost of goods sold 2,000Estimated inventory $16,000

26

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

27

Salad Oil Swindle

Tino DeAngelis rented a petroleum tank farm in Bayonne, New Jersey.

28

Salad Oil Swindle

He convinced auditors, investors, and investment bankers that the tanks

contained $100 million in vegetable oil.

29

Salad Oil Swindle

The tanks actually were primarily filled with sea water. There was very little

vegetable oil in the tanks.

30

Salad Oil Swindle

Tino would pump vegetable oil from one tank to another, depending on his advance

knowledge of the auditor’s verification plan.

31

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


Step No. 2Determine Cost Percentage

Goods available for sale at cost $ 6,000Divided by goods available for

sale 12,000Cost percentage 50%

36

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


Ending Inventory at Retail $5,400 Times Cost Percentage x 50%Ending Inventory at Cost $2,700

Step No.4Determine Ending Inventory at Cost

38

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

39

Goods available for sale at cost $ 6,000Divided by goods available for

sale at retail 11,400Cost percentage 52.6%


Step No. 2Determine Cost Percentage

40

Step No. 3Determine Ending Inventory at Retail


Goods available for sale $11,400 Less sales (6,000)Less markdowns (600)Ending inventory at retail $ 4,800

41

Step No.4Determine Ending Inventory at Cost


Ending inventory at retail $4,800 Times cost percentage x 52.6%Ending inventory at cost $2,525

42


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

43


Beginning Inventory

+Purchases= Goods Available for Sale

Goods Available for Sale: At Cost

ContinuedContinued

To calculation of cost percentage

44


Cost Percentage:Cost/Retail

x Cost Percentage

Estimated Ending Inventory at Retail

Estimated Ending Inventory at Cost

45

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.


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

49

Dollar- Inv @ Value



1999 $60 ÷ 1.00 = $60 $60 x 1.00 x 0.60 = $36

Dollar-Value LIFO RetailInventory Method--Example

50

Dollar- Inv @ Value



1999 $60 ÷ 1.00 = $60 $60 x 1.00 x 0.60 = $362000 $69 ÷ 1.05 = $66


51

Dollar- Inv @ Value



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


52

Dollar- Inv @ Value



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


53

Dollar- Inv @ Value



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


54

Dollar- Inv @ Value



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


55

Dollar- Inv @ Value



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


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


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


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

61

The End

inventory valuation at other than cost

Documents

market inventory

market value of inventory

lower market cost

estimated inventory

lower cost

inventory count

valuing inventory

inventory valuation