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