9 Inventories: Additional Valuation Issues i CHAPTER LEARNING OBJECTIVES Describe and apply the lower-of-cost-or-net realizable value rule, Explain when companies value inventories at net realizable value. A Explain when companies usc the relative sales value method to value inventories. 3 Disenss accounting issues related to purchase commitments, Determine ending inventory by applying the gross profit method. Determine ending inventory by applying the retail inventory method. Explain how to report and analyze inventory. ‘CHAPTER REVIEW 1. Chapter 9 concludes the discussion of inventories by addressing certain unique valuation problems not covered in Chapter 8. Chapter 9 also includes a description of the development and use of atious estimation techniques used to value ending inventory without a physical count. --of-Cost-or-Net Realizable Value (LCNRV) 2. (LO. 1) When the future revenue-produeing ability associated with inventory is below its foriginat cost, the inventory should be written down to reflect this foss. Thus, the historical cost principle Is abandoned when the future utility of the asset is no longer as great as its original cost. When this report their inventories at the lower-of-cost-or-net realizable value (LCNRV). The oss of utility in inventory should be charged against revenue in the period in which the loss occurs (not in fine period of sale). 3. Accompany may apply the LCNRV (a) directly to each item, (b) to a group of similar or related ems, or (c) to the total inventory. The individual-item approach is preferred by many companies because tax rules require its use when practical, and it produces the most conservative inventory valuation fa the statement of financial position, Whichever method a company selects, it should apply the method Eensistently from period to period. Net Realizable Va 4. Two methods are used to record inventory at net realizable value. ‘The cost-of-goods-sold thod records the write-down of inventory to NRV as part of cost of goods sold, Thus, the loss is ed in the cost of goods sold and no individual loss account is reported in the income statement. Under second method, referred to as the loss method, the write-down of inventory to NRV is recorded as a bitto a separate loss account. IFRS does not specify a method to use, but recording the loss separately not distort the cost of goods sold and clearly displays the loss that results from a market decline. To9-2 student Sindy Guide for Xeso Inermediate Accounting: IFRS Edition, Volume Teduce the inventory to NRV on the statement of financial position, companies generally eredit an allowance account, rather than erediting the inventory account directly. 5, If economic conditions change and the net realizable value of inventory previously written down has now recovered to the point that it’s above cost, the amount of the original write-down is reversed (limited to the amount of the original write-down). Val 6 (LO. 2) Generally, inventory is recorded at the LCNRV. However, there are two common situations where net realizable value is the general rule for valuing inventory: agricultural assets and ‘commodities held by broker-dealers. 7. Agricultural assets consist of biological assets and agricultural produce. Biological assets are nonousrent assets that are living animals or plants such as sheep or fruit trees. Agricultural produce is the product harvested from a biological asset, such es wool or apples. Biological assets are valued at fair ‘value less costs to sell (NRV), with gains and Josses in value reported in income in the period they arise. Agricultural produce is measured at the point of harvest at fair value less costs to sell (NRV). Subsequent to harvest, this value becomes the cost of the agricultural produce and it is accounted for similar to other inventory held for sale in the ordinary course of business. 8. Commodity broker-dealers buy and sell commodities (such as harvested com or gold) for others or for themselves. Their main objective is to sell the commodities in the near future to profit from price fluctuations. These inventories are valued at fair value less costs to sell (NRV). 9, (LO. 3) When a group of varying inventory items is purchased for a lump sum price, a problem exists relative to the cost per item, ‘The relative sales value method apportions the otal cost to individual items on the basis ofthe selling price of each item Purchase Commitments 10. (L.O. 4) Purchase commitments represent contracts for the purchase of inventory at a specified price in a future period. If material, the details of the contract should be disclosed in a note of the buyer’s statement of financial position. If the contract price is in excess of the market price and it is expected that losses will occur when the purchase is effected, the loss should be recognized in the period during which the market decline took place. ‘The Gross Profit Method <) 11. (L.O, 5) The gross profit method is used to estimate the amount of ending inventory. Its use is not appropriate for financial reporting purposes; however, it can serve a useful purpose when an approximation of ending inventory is needed, Such approximstions are sometimes required by auditors ‘or when inventory and inventory records are destroyed by fire or some other catastrophe. The gross profit method should never be used as a substitute for a yearly physical inventory unless the inventory has been destroyed, The gross profit method is based on the assumptions that (a) the beginning inventory plus purcheses equal total goods to be accounted for; (b) goods not sold must be on hand; and (e) if sales, reduced to cost, are deducted from the sum of the opening inventory plus purchases, the result is the ending inventory.[Chapter 9: Inventories: Additonal Vatuation tssaes 93 ‘The Retail Inventory Method 12. (L.O. 6) The retail inventory method is an inventory estimation technique based upon an observable pattern between cost and sales price that exists in most retail concerns. This method requires that a record be kept of (a) the total cost and retail of goods purchased, (b) the total cost and retail value of the goods available for sale, and (c) the sales for the period. 13, Basically, the retail method requires the computation of the cost-to-retail ratio of inventory available for sale. This ratio is computed by dividing the eost of the goods available for sale by the retail value (selling price) of goods available for sale. Once the ratio is determined, total sales for the period ate deducted from the retail value of inventory available for sale. The resulting emount represents ending inventory priced at retail. When this amount is multiplied by the cost to retail ratio, an approximation of the cost of ending inventory results. Use of this method eliminates the need for a physical count of jnventory each time an income statement is prepared. However, physical counts are made at least yearly {o determine the accuracy of the records and to avoid overstatements due to theft, loss, and breakage. 14, To obtain the appropriate inventory figures under the retail inventory method, proper treatment ‘must be given to markups, markup cancellations, markdowns, and markdown cancellations. 15, When the cost to retail ratio is computed after net markups (merkups less markup cancellations) have been added, the retail inventory method approximates lower of cost or net realizable value. This is known as the conventional retail inventory method. If both net markups and net markdowns are ‘included before the cost to retail ratio is computed, the retail inventory method approximates cast. 16. The retait inventory method becomes more complicated when such items as freight-in, purchase returns and allowances, and purchase discounts are involved. In essence, the treatment of tue items affecting the cost column of the retail inventory approach follows the computation of cost of Fsoods available for sale. Freight costs are treated as a part of the purchase cost; purchase returns and lowances are ordinarily considered a reduction of the price at both cost and retail; and purchase discounts usually are considered as a reduction of the cost of purchases. 17. Other items that require careful consideration include transfers-in, normal shortages, Eiinormal shortages, and employee discounts, Transfers-in from another department should be reported the same way as purchases from an outside enterprise. Normal shortages should reduce the retail Fviumn because these goods are no longer available for sale. Abnormal shortages should be deducted ‘both the cost and retail columns and reported as a special inventory amount or as a loss. Employee ts should be deducted from the retail column in the same way as sales. 18, The retail inventory method is widely used (a) to permit the computation of net income without physical count of inventory, (bras a control measure in determining inventory shortages, (c) in ing quantities of inventory on hand, and (4) for insurance information. £19. Taventories normally represent one of the most significant assets held by a business entity. [ttrefore, the accounting profession has mandated certain disclosure requirements related to inventories. ‘of the disclosure requirements include: the composition of the inventory, the inventory financing, ory costing methods employed, and whether costing methiods have been consistently applied.9-4 Student Study Golde fer Kieso Inarmediate Accounting: IFRS Edin, Volune 1 GLOSSARY Agricultural assets, Include both biological assets (living animals and plants) and G agricultural produce (harvested from the biological asset). Cost-to-retail ratio. Total goods available for sale at cost divided by the total goods available at retail. Gross profit method. ‘A method for estimating the ending inventory by applying @ ‘g108s profit rate to net sales. Lower of cost or net A basis whereby inventory is stated at the lower of cost or net realizable value realizable value. «LCNRV). Markdown, ‘A decrease below the original retail price. Markdown cancellation. ‘An increase in the selling price that follows a markdown, A ‘markdown cancellation will never increase the selling price above the original retail price. Markup. An increase above the original retail price. Markup cancellation, A decrease in the selling price of an item that had been previously marked up above the original retail price. A markup cancellation will never reduce the selling price below the original retail price. Net realizable value. The estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal. Original retail price. “The price at which the item was originally marked for sale. Purchase commitments, Agreements to buy inventory weeks, months, or even years in advance. Retail inventory method. ‘A method used to te the cost of the ending inventory by applying a cost to retail ratio to the ending inventory at retail.‘Chapter 9: Ioventorles: Additonal Valuation Issues 25 CHAPTER OUTLINE Fill in the outline presented below. (L.O. 1) Lower of Cost or Net Realizable Value (L.O. 3) Valuation Using Relative Sales Value (L.O. 4) Purchase Commitments (L.O. 5) The Gross Profit Method of Estimating Inventory Computation of Gross Profit Percentage % 8 (L.0. 6) The Retail Inventory Method i is 5 Conventional Method—With Mackups and Markdowns i 4 | (1.0.7) Presentation and Analysis of Inventories ‘ } |i 9-6 Student Study Guide for Kieso Intermediate Accounting: IFRS Edin, Volume T DEMONSTRATION PROBLEMS 1. (1.0.2) Stock Farms has 1,000 sheep that are being raised for their wool production. The company] began operating on January 1, 2011 by purchasing the sheep for $275,400. The following information is| available at December 31, 2011: ‘Sheep Carrying value 1/1/11 $275,400 Change in fair value due to growth 14,300 ‘Decrease in value due to shearing 8,600 Value of wool from shearing 33,600 [What is the value of the sheep as reported in Stock Farms" statement of financial position at December| 31, 20117 Solution: Sheep Carrying value, 1/1/11 $275,400 Change in value due to growth 14,300 Decrease in value due to shearing (8,600) Carrying value, 12/31/11 $281,100 2. (L.0.5) Compute the approximate ending inventory for the Fox Department Store assuming: beginning inventory (cost), $85,000; purchases (cost), $226,000; sales at selling price, $345,000; average| gross profit rate on selling prices is 38%. Solution: Beginning inventory $ 85,000 Purchases 226,000, Goods available 311,000 Sales $345,000 Less gross profit 131,100" Sales at cost 213,900 ‘Approximate ending inventory 397.100 "38% » 345,000).‘Chapter 9: Inventories: Additional Valuation Isues oT IEW QUESTIONS AND EXERCISES RUE-FALSE, dicate whether cach of the following is true (T) or false (F) in the space provided. 1. 16. (L.0. 1) Inventory should be written down to net realizable value when its revenue-producing ability js no longer as great as its cost. (L.O. 1) In most eases, companies apply lower-of:cost-or-net-realizable value on an item-by-item basis. ss less the (LO. 1) Net realizable value is the estimated selling price in the normal course of bus ‘normal profit margin, (L.O. 1) Itis acceptable practice to write down inventory to net realizable value when net realizable value is lower than cost, but it is not acceptable to write up inventory to net realizable value when net realizable valuc is higher than cost. (LO. 1) The loss resulting from the write-down of inventory to net realizable value normally should bbe shown in the income statement following net income, net of tax. (1.0. 1) If inventory is written down to net realizable value in one period, it may be written back up {0 its original cost in a subsequent period. (L.0. 2) Under the lower-of-cost-or-nel-realizable-value rule, the income statement may show @ larger net income in future periods than would be justified if the inventory were cartied forward at cost. (LO. 2) Under the lower-of-cost-or-net-realizable-value rule, an item of inventory should not be valued at an amount in excess of net realizable value, (LO, 2) The application of the lower of cost or net-realizable-value rule to the inventory as a whole ‘would yield a tower inventory value than would application of the rule to each individual item, {L.0. 2) The recognition of invemtories at selling price less cost of disposal means that income is usually recognized before the goods are transferred to an outside party, (LO. 3) The allocation of a lump sum cost among the individual units on the basis of relative sales value assumes that each individual unit should show the same dollar amount of profit. (L.0, 4) No asset or liability is recognized at the inception of a purchase commitment because the ‘contract is “exeoutory” in natuce, LO. 4) The account Accrued Loss on Purchase Commitments should be included in the stockholders” equity section of the statement of financial position, (L.O. 4) ‘If the contracted price under a purchase commitment is tess than market and it is expected that gains will occur when the purchase is effected, gains should be recognized in the period during ‘which such increases in market prices take place. (L.O. 5) Gross margin is the excess of selling price over cost. (L.O. 5) The gross margin expressed as @ percentage of cost is normally less than the gross margin expressed as a percentage of sales.9-8 Student Study Guide for Kieso Imermediate Accounting: TFRS Eatin, Volum I T7. (6, 5). The use of the gross profit method for imerim Teports does not preclude the need for a physical inventory to be taken at least annually. & 18. (L.0.6) Regardless of which version is used, the retail inventory method is permitted under IFRS. 19, (1.0, 6) The retail inventory method isnot useful for interim reports. 20. (L.0. 6) The conventional retail method includes net markdowns but excludes net markups in the ‘computation of the cost to retail percentage. 21. (L.0. 6) The inclusion of both net markups and net markdowns in the computation of the cost fo retail percentage yields an inventory valuation that approximates cost. 22. (L-0.6) The retail method assumes that the mix of the ending inventory is the same as the mix of the total goods available for sale, 23. (LO. 6) The conventional retail inventory method is designed to approximate the lower of averaze cost or net realizable value. 24. (L.0.7) The basis upon which inventory amounts are stated (lower of cost or net realizable value) and the method used in determining cost (FIFO, average cost, etc.) should be disclosed in the notes of the financial statements. 25. (L.O. 8) The inventory turnover ratio measures the number of times, on average, a company sells its inventory during a period. MULTIPLE CHOICE Select the best answer for each of the following items and enter the corresponding letter in the space provided. 1. (LO. 1) Which of the following represents the best justification for the departure from the historical ‘cost principle that results when lower of cost or net realizable value is used? ‘A. Itis casierto Koop track of net realizable value than itis to keep track of cost. B. Cost loses its relevance for the determination of cost of goods sold if the cost of inventory has been incurred in an earlier accounting period. | €. The statement of financial position valuation of inventory is the most important ‘consideration in the preparation of financial statements. D. The loss in utility that results from a decline in the net realizable value of inventory should be charged against revenues in the period in which iteceurs. 2. (LO. 1) ‘The lSwér of cost or net realizable value rule suffers from some conceptual deficiencies including ‘A. Taconsistent treatment of decreases in the value of inventory compared to increases in value of inventory. B. Inconsistency in valuation on the statement of financial position in that jnventory may . be at cost one year and at net reatizable value the following year. ©. Using lower of cost or net realizable value may result in income being higher than expected in a subsequent period. D. _Allof the choices are correct.(Chapter 9: Inventories: Additional Valuation Issues 99 (LO. 1) When using the lower-of-costor-net-realizable-value rule, what is the meaning of “net realizable valuc"? A. Discounted present value. B. Selling price tess costs of completion and disposal. C. Current replacement cost. D. Selling price less « normal profit margin. (L.0.1) A dudad has an original cost of $15 and a replacement cost of $12. The cost of completion and disposal is $2. If the dudad fas « sales value of $16 and a normal profit margin of $5, its inventory value should be: A SIS Bo SIZ GQ si6 D. Sia (LO. 1) Daring Year 1 a sat of inventory has declined in value below original cos, and is reported ‘on the statement of fina jon at its net realizable value, In Year 2 the inventory item’s value recovers such that ils me realizable value is now above hs eos. The reported valve ofthe inventory item on the Year 2 statement of financial position is: A. Original cost. B. Year | net realizable vatue, C. Year 2 net realizable value. D. Any of these values may be used. (0. 1) Let A equal tho reported inventory value if the lower-of-cost-or-net-realizable-value (LCNRY) rule is applied (o individual items of inventory; B equals the reported inventory value if the LCNRY rule is applied to the inventory as a whole, Which of the following best describes the relationship between A and B? A. Awill always be equal to B. B. _A.will always be equal to or less than B. CC. A.will always be equal to or greater than B. D. — Acannever be equal to B. (LO. 1) In 2011, Martinez Corporation experienced a decline in the value of its inventory resulting in a write-down of its inventory from $550,000 to $430,000. The company used the loss method in 2011 to record the necessary adjustment and uses an allowance account to reduce inventory to NRV. In 2012, market conditions have improved dramatically and Martinez, Corporation’s inventory increases 0 $616,000. Which of the following will Martinez record in 2012? ‘A. A debit to recovery of inventory loss, $186,000, B.A debitto recovery of inventory loss, $120,000. C. A credit to repovery of inventory toss $120,000. D. —_ Acctedit to recovery of inventory loss, $66,000,9-10 ‘Student Study Guide for Riso ncenmediae Accocatngs IFRS Eaton, Volume T 8 ir 12, 13. (C.0.2) Agricultural produce is: A. alliving animal or plant such as a cow or a tree, B, reported at net realizable value at each statement of financial position date. C. harvested product from a biological asset. D. —_Alloftthe choices are correct, (L.0. 1) When the eost-of-goods-sold method is used to record inventory at net realizable value: there is a direct reduction in the selling price of the product that results in a loss being recorded on the income statement prior to the sale. a loss is recorded directly in the inventory account by crediting inventory and debiting loss on inventory decline. only the portion of the foss attributable to inventory sold during the period is recorded in the financial statements. the net realizable value figure for ending inventory is substituted for cost and the loss is buried in cost of goods sola. vow > (L.0. 2) Commodity broker-traders record inventory at Lower of cost or net realizable value Historical cost ‘Net realizable value, with changes in NRV recorded in net income Any of the choices is acceptable, gowp (L.0. 2) Biological assets: A. Include harvested products such as wool, mil, and cotton. B. __Arerecorded in the statement of financial position at lower of cost or net realizable value. C. Have changes in value recorded as part of comprehensive income. D. None of the above, (L.0. 3) ‘Tract Homes purchases 105 home lots for # lump sum of $1,000,000. The 105 lots include 5 type “A” lots valued at $150,000 each; $0 type “B” lots valued at $10,000 each; and 50 type “Clots valued at $3,000 each, Using the relative sales value method, the value assigned to each type “A” lot is (round to the nearest dollar) A $9,524 B. $150,000 c.— $100,000 D. $66,667 (LO. 4) Maricel Company has a noncancelable purchase commitment to buy 10,000 units of a particular product during the next three yeacs. The contract was signed one year in which the purchase commitment must be honored. At the end of the year in whi signed Mericel Company should formally recognize in its statement of financial position: Am Asset A ‘Yes B, No c. Yes D. NoChapter 9: Inventories: Additional Valuation ues Se Me. 15. 18. 19. (E.0. 5) Which of the following is not a basie assumption of the gross profit method? A. The beginning inventory plus the purchases equal total goods to be accounted for. B. Goods not sold must be on hand. C. Ifthe sales, reduced to the cost basis, are deducted from the sum of the opening inventory plus purchases, the result is the amount of inventory on hand. 1D. The total amount of purchases and the total amount of sales rem: comparable previous period. relatively unchanged from the {L.0. 5) On January 31, fire destroyed the entire inventory of Mojares Company. The following data are available: Sales for January $60,000 Inventory, January 1 10,000 Purchases for January 35,000 Markup on cost 25% ‘The amount ofthe loss is estimated to be: A. $17,000 B. $20,000 c — $15,000 D. $16,250 (L.O. 5) Devers Company sells its product for $25.00 per unit. This price is set to yield a gross ‘margin on selling price of 25%. What is the cost of the product and what is the markup on cost for the product? Cost Markup of Product ‘on Cost $6.25 40% 8975 13% 312.50 20% 318.75 33% pomp (LO. 6) Which ofthe following is nor required when using the retail inventory method? All inventory items must be categorized according to the retail markup percentage which reflects the item's selling price. ‘A record of the lotal cost and retail value of goods purchased. ‘A record of the total cost and retail value of tne goods available for sale, Total sales for the period. gos > (L.0. 6) To determine an inventory valuation that approximates lower of average cost or net realizable value using the retail method, the computation of the cost to retail percentage shoutd: include markups Bt not markdowns. include markups and markdowns, include markdowns but not markups. ‘exclude markups but not markdowns. pomp (LO. 6) The retail method has been used by a retail department store during is frst year of As of the end of the year, compare (A) the markdowns with (B) the markdown A, Awill be equal to B. B. Ail be less than or equal to B, C. Ail be greater than or equal to B. D, —A-camot be equal to B.9-12 Student Study Guide for Kioso nermediat: Accounting: IFRS Retin, Volume 1 720. (L.0. 6) Phair Co, a specialty clothing store, uses the retail inveniory method. The following relates ‘0 2010 operations: Inventory, January 1, 2012, at cost $14,200 Inventory, January 1, 2012 at sales price 20,100 Purchases in 2012 at cost 32,600 Parchases in 2012 at sales price 50,000 ‘Additional markups on normal sales price 1,900 Sales (including $4,200 of items that were marked ‘down from $6,400) 60,000 ‘The cost of the December 31, 2012 inventory determined by the conventional retait method is: A. $9,800 B. $6,370 C. $6,743 D, $6,543 21. (L.0. 6) One of the basic assumptions of the conventional retail method is that: ret markups apply to the goods sold. net markdowns apply to the total goods available for sae. net markdowns apply only to the goods sold, the cost to retail percentage is unchanged from that of prior years ppp . 22. (LO. 6) Under the cetail inventory method, purchase returns and allowances are normally considered a reduction of price at: Cost Retail A No No B. No Yes c Yes No D. Yes Yes Items 23 and 24 are based on the following information: ‘The Stipes Company uses the relail-inventory method to value its merchandise inventory. The following information is available: Gost Retall Beginning inventory ‘$ 30,000 $ 60,000 Purchases 190,000 300,000 Freight-in 1,000, - Markup (net) - 2,000 : Markdowns (net) 4.000 ! Employee discéunts 1,000 Sales 290,000 | | i(Chapter 9: Inventories: Additonal Valuation Issues 9-13 23. (L.0.6) What's the ending inventory at retal? A. $66,000 B. $67,000 c.— $69,000 D. $71,000 24. (L.O. 6) If the ending inventory is to be valued at the lower of cost or net realizable value, what is the cost-to-retail ratio? A. $221,000/8362,000 B. —_$221,00018360,000 Cc. — $221,00018358,000 D. —_$221,00018357,000 25. (LO. 6) Which of the following is not a reason the retail inventory method is used widely: ‘A. as.acontcol measure in determining inventory shortages. B. for insurance information. © to permit the computation of net income without a physical count of inventory. D. to defer income tax liability.9-14 Student Study Guide for Kiso Intermediate Accouctng: IFRS Edition, Volume { REVIEW EXERCISES 1. (1.0.1) Josie Bisset Company determines its inventory using the lower of cost or net realizable value inventory valuation. For the years ended 12/31/011 and 12/31/12 the data for inventory values at cost and net realizable value are as follows: ‘Net Realizable Cost Value 12/311 $296,000 $272,000 12/3142 $321,000 $306,000 Instructions: i 8, Prepare the journal entries requiced at 12/31/011 and 12/31/12, assuming that the cost-of-goods-sold method is used and that rather than adjusting the inventory account directly, an allowance account is used. b. Prepare the journal entries required at 12/31/01 and 12/31/12, assuming that the Joss method! is used and that rather than adjusting the inventory account directly, an allowance account is used. ‘General Journal i Date Account Title Debit Credit‘Chapter 9: Inventories: Additonal Valuation Issues Se15S General Journal wa Date Account Title Debit Credit |9-16 Student Study Gude for Kieso Inermediate Accounting: IFRS Edition, Volume 1 2, _ (L.0.5) Scholl Company uses the gross profit method to estimate monthly inventory balances. During recent months, gross profit has averaged 30% of net sales. ‘The following data for January are obtained fiom the ledger: Inventory, January 1 $ 30,000 Purchases... 100,000 Purchase returns. 2,000 Freight-in.... 3,000 Sales.. - 120,000 Sales returns. 4,000 Instructions: Compute the January 31 inventory.Chapter: Investris: Additional Valuation sues ef 3 l:0-5) Calabro Tne. had a majority oF ie inventory destroyed by a fire just prior Yo year end. The company controller had kept the accounting records current and provided you with the following account balances, Beginning inventory $67,500 Purchases for the year 235,700 Purchase returns 17,500 Sates 326,800 Sales returns 16,200 Gross profit rate on sales 36% Inventory with a selling price of $18,000 was undamaged by the fire. Damaged inventory with an eriginal sclling price of $10,000 had a net realizable value of $4,800, Instructions: Compute the amount of the loss caused by the fire, assuming no insurance coverage is cartied by the company.(Chapter 9: Inventories: Additonal Valuation ssues 9-17 3. (L.0.5) Calabro ine. had a majority of is inventory destroyed by a fire just prior to year- end. The company controller had kept the accounting records current and provided you with the following account balances. Beginning inventory $67,500 Purchases for the year 235,700 Purchase returns 17,500 Seles 326,800 Sales returns 16,200 Gross profit rate on sales 36% Inventory with a selling price of $18,000 was undamaged by the fire. Damaged inventory with an original selling price of $10,000 had a net realizable valuc of $4,800, Instructions: Compute the amount of the loss caused by the fire, assuming no insurance coverage is carried by the company. wae9-18 student Study Guide for Kieso Intermediate Accounting: TPRS Eakin, Volum 1 4, (L.0, 6) The following information for the month of April is available from the records of Ireland Department Store: AtCost tet Inventory, April | $8,400 $12,000 Purchases 48,810 80,000 Freight-in 2,000 ‘Additional markups 4,300 Markup cancellations 800 Markdowns 6,600 Markdowns cancellations 200 Sales 72,600 Instruction: ‘Compute the April 30 inventory at the lower of cost or net realizable value using the conventional retail method.[Chapter 9: Tnveotories: Addional Vawuation sues 9-19. SOLUTIONS TO REVIEW QUESTIONS AND EXERCISES ‘TRUE-FALSE © 2 @) 3. (F) Net realizable value is defined as selling price les the estimated cost of completion and disposal 4 0 5. (F) The loss resulting ftom the write-down of inventory to market is shown as a separate item in the income statement but not net of tax and not following net income. 6 zm & @ 9. (F) The lower-of-costor-net-realizable-value (LCNRV) rule may be applied directly to each item or to the fotal of the inventory. When the LCNRV rate is applied to the inventory as a whole, increases in the net realizable valuc of some items offset decreases in the net realizable value in ‘other items to some extent. Thus, the application of the LONRY rule to individual inventory items gives the lowest valuation for statement of financial position purposes. % © 11, (F) When the relative sales value method is used, it is used because the items being valued vary in terms of such chetacteristics as shape, size, attractiveness, and so on. Because of these types of differences, the amount of gross profit generated by each item will be different. 2m 13.) if the contracted price of a purchase commitment is in excess of market price and itis expected that losses will occur when the purchase is effected, a loss should be recognized and an Accrued Loss on Purchase Commitments should be eredited. ‘The loss is reported on the income statement ‘under other expenses and losses, and the Accrued Loss is reported in the liability section of the statement of financial position. 14, )__If the contracted price is in excess of market and it is expected that losses will occur when the purchase is effected, losses should be recognized in the period during which such dectines in market prices take place, Gains are not recognized until they are realized. 1s. 16.) __Because selling price is greater than cost and the gross margin amount is the same for both, gross ‘margin on selling price will always be less than the related percentage based on cost. ™ m 18 (1)9-20 ‘Student Study Guide for Kes Sotermediate Accounting: IFRS Edition, Voluce} 19. (F) Because a fairly quick and reliable measure of inventory value is usually needed, the retail inventory method is particularly useful for any type of interim report. 20. (E) The conventional retail inventory method is designed to approximate the lower of average cost or net realizable value, Thus, the cost percentage computation includes markups but not markdowns. When a company has an additional markup, it normally indicatcs that thc market value of that item had increased, Ifthe company has a net markdown, it means that a dectine in the utility of that item has occurred. ‘Therefore, if the attempt is to approximate lower of cost or net realizable value, markdowns are considered a current loss and are not involved in the caleulation of the cost to retail ratio, a. 2 (1 2B. 4 28. (1) MULTIPLE CHOICE, 1. ©) The general rule is thatthe historical cost principle is abandoned when the fature utility (fevenue producing ability) of the inventory is no longer as great as its original cost, It is no easier to keep track of net value than it is to keep track of cost, and cost does not lose its relevance if net realizable value remains in excess. The statement of financial position valuation is not the most Significant reason for lower of cost or net realizable value, 2. (DB) Allofthe choices describe conceptual deficiencies of the LCNRV rule, 3. (B) “Net realizable value” as used in the lower-of-cost-or-net-realizable-value rule is the selling price less costo complete and sell the inventory item. 4. (D) Net Realizable Value $16-2=514 Original Cost 2 SIS Application of the LCNRY rule would result in the dudad being recorded at its NRV of S14. 5. (A) [feconomic conditions change and the net realizable value of inventory previously written down hhas now reeqvered (0 the point that It's above cost, she amount of the original write-down is reversed (limited to the amount of the original write-down) and the inventory item is reported on the statement of financial position at its original cost. 6. (8) __ Increases in the net realizable value of some inventory items tend to offset decreases in other inventory items when the LCNRV rule is applied to the inventory as a whole. Thus, the invenvory valuation that results from applying the LCNRV method to individual items in inventory (altemative A) will always be equal to or less than the inventory valuation that results from applying the LCNRV rule to the inventory as a whole (altemative B). 7. (©) The value of the inventory has recovered above its original cost. In this case, Martinez should report the reoavery of an inventory loss with a credit of $120,000 (difference between the inventory’s old NRV of $430,000 and the cost of the inventory, $550,000). ‘This amount represents the recovery of the previously reported loss of $120,000.Chapter 9: taventories: Additional Valuation issues 9-21. % (©) Agricultural produce is harvested product from a biological assel such as a cow or a tree. Wis valued at net realizable value at the point of harvest; subsequent to harvest it is accounted for similar to other inventories. 9. (D) Under the cost-of-goods-sold method, no entry for the decline in the value of the inventory is recorded. Merely, the ending inventory value used in computing cost of goods sold is valued at net realizable value (which is lower than cost) and the cost of goods sold that results is larger. This results in a lower net income so the loss is technically buried in the cost of goods sold computation, 10. (C) Commodity brokerraders measure inventories at net realizable value, with changes in NRV recognized in net income in the period of change. I. (D) Biological assets include living animals or plants, are reported at net realizable value, and changes in net realizable value ate reported in income ns they aise, 12, (©) Using the relative sales value method, the value assigned to each type “A” lot is $100,000 determined as follows: ‘Type “A” 5 * $150,000 $ 750,000 ‘Type “B” 50 * $10,000 500,000 Type “C" 50x $5,000 250,000 Tofal sales value 81,500,000 Cost allocated to type “A” lots $750,000/51,500,00 = 50% = $1,000,000 50% = $500,000/5 = $100,000 x 1, (B) Even with formal, noncencelable purchase contracts, no asset or lability is recognized at the date of inception, because the contract is “executory” in nature; neither party has fulfilled its part ofthe contract, However, if material, such commitment details should be disclosed in the buyer's statement of financial position in a footnote. 14 (D) The gross profit method assumes a constant gross profit percentage, but makes no assumptions about the tol amount of sales or purchases, Alternatively (A), (B), and (C) are basio assumptions of the gross profit method. 15, (A) .25% markup on cost is equivalent to 8 20% markup on selling price: % markup on cost : GP on selling rice = T0596 39% markup on cost : GP on selling price GP on selling price = .20 Sales.. $60,000 GP ($60,000 * 20)... 12,000 ' Cost of goods sold. $48,000 i Goods available for sale.. 65,000 Inventory loss9-22 snadent Stady Gute for Kies Intermediate Accounting: IFRS Editon, Volume L 16) + 258P= SP C= (1 ~.25)SP G ‘Markup on Cost = $6.25 + $18.75 =33% 17, (A) Inventory items need not be categorized in any manner. The major benefit of the retail inventory ‘method is that inventory items are accumulated without the need to separate them into distinct classifications. Altematives B, C and D reflect the requirements for use of the retail inventory method. 18. (A) See explanation of True-False question No. 20. 19, (©) Markdown cancellations represent the cancellation of previous markdowns applied to a prodoct. Therefore, markdown cancellations are limited to the total amount of markdowns previously recorded. Thus, for any entity, markdowns will be greater than or equal to markdown cancellations. 20. @) Cost Retail Inventory 1/1/12. een Purchase 32600 _$0.000 i * 346,800 $70,100 ‘Additional Markups 1.900 TOtAIS crn $46,800 372,000 : ‘(Cost-to-retail ratio: $46,800 + 72,000 = 65%) i Deduct Markdowns, sunnennnne 2.200 i Sales Price of Goods AVailaDI¢ va nunoe 569,800 ‘ Deduct Sales 69.000, Ending Inventory at Retail 32.900 Ending Inventory at LCM: $9,800 » .65 = $6,370 I 21. (C) When the attempt is to approximate lower of cost or net realizable value, under the retal inventory method, markdowns are considered a current loss and are not involved in the calculation ofthe costo retail ratio, 2%. (PD) Purchase returns and allowances are ordinarily considered both as a reduction of the price at cost and retail.(Chapter 9: laventories: Additonal Valuation Issues 9-23, 24, 2. @ @) ‘Stipes Company’s ending inventory at retnil can be calculated as follows: Retail Beginning inventory $ 60,000 Purchases 300,000 Available $360,000 Add: Markups, net — 2.000 $362,000 Less: ‘Markdowns, net 34,000 Employee discounts 1,000 5,000 $357,000 Less: Sales 290,000, Ending inventory at retail $67,000 Stipes Company's cost-to-retal ratio approximating lower of cost or market can be determined as follows: Cost Retail Beginning inventory $ 30,000 $ 60,000 Purchases: 190,000 300,000 Freight-in 1,000 - s221,000 360,000 Add: Markups, net 2.000 uez.000 The cost-to-retail ratio approximating lower of cost or market includes net markups but not net ‘markdowns: $221,000/$362,000= 61.05%. ‘The retail inventory method is used widely (I) to permit the computation of net income without a } count of inventory, (2) as a control measure in determining inventory shortoges, (3) in quantities of merchandise on hand, aud (4) for insurance information. ‘The retail inventory method does not necessarily cause a decrease in income taxes like LIFO during a period of rising prices.9-24 Student Seady Gute for KiesoItermediate Accounting: IFRS Edition, Volume t REVIEW EXERCISES Loa I2BV/1L Cost of Goods Sold sen 24,000 Allowance to Reduce Inventory 24,000 12/31/12 Allowance to Reduce Inventory 9,000 Cost of Goods Sold nnn one 9,000 b. 1281/11 Loss Due to Decline in Inventory to NRV... 24,000 Allowance to Reduce Inventory .. . 24,000 12/31/12 Allowance to Reduce Inventory 9,000 Recovery of Loss Due to Decline in Inv. to NRV.. 9,000 Inventory at cost, 12/31/11 . Inventory at LCNRY, 12/31/1. Allowance needed to reduce inventory to LCNRV ! Inventory at cost, 12/31/12 .. Inventory at LCNRV, 1231/1 Allowance needed to reduce inventory to LCN’ Recovery of previously recognized loss $24,000 - $15,00 y ! 2, Inventory, January. $30,000 } Purchases: . 100,000 Freight-in ssc wane 3,000 Purchase returns... vn — (2,000) Goods available (at cost)... $131,000 t Sales... $120,000 Sales returs... 4,000 Net sales.. se $116,000 Less gross profit (30% of 116,000) 34,800 i Cost of goods sold. 81,200 i Inventory, January 31 (at cost) (131,000 81,200) . £49300 b 3. $326,800 f (16.200) I 310,600 I __36 : Cost of goods sold: $310,600 ~ $111,816 = $198,784 i Beginning inventory 8 67,500 Purchases 235,700 Purchase returns... 17,500 ‘Net purchases...ssseasseen 218, : Goods available for Sale ..nmemen $285.00) : Estimated ending inventory: $285,700 - $198,784 = $86,916Chapter 9: Inventories: Additional Valuation Issues. 9-25 + Tnventory loss due to fire: L Estimated ending inventory $86,916 3 Undamaged inventory [$18,000 — ($18,000 (11,520) NRV of damaged goods... (4,800) Loss due to fire. ‘$70,596 Cost Retail Inventory, April 1 $8,400 $12,000 Purchases, 48.810 80,000 Freight-in. 2,000 ‘Net markups. 3,500 Goods available. $59,210 $95,500 Cost to retail ratio $9.210/95,500 = 62.0% Less: 1 Sales 72,600 4 Net markdowns, 6.400 t 79.000 . ‘ Inventory, April 30, at retail $16,500 | Inventory, April 30, at lower of cost or market (16,500 x .62). $10,230 ‘