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CHAPTER 9

CHAPTER 9. Inventories: Additional Valuation Issues. ……..…………………………………………………………. Lower of Cost or Market. basis for valuation of inventory “lower of cost or the cost to replace” matching principle; conservatism. Designated Market Value. 2. Ceiling = net realizable value.

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CHAPTER 9

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  1. CHAPTER 9 Inventories: Additional Valuation Issues ……..…………………………………………………………... Lower of Cost or Market • basis for valuation of inventory • “lower of cost or the cost to replace” • matching principle; conservatism

  2. Designated Market Value 2 Ceiling = net realizable value (selling price less cost of completion) 1 replacement cost 3 Floor = net realizable value less normal profit margin • always pick the middle value

  3. Methods of Applying Lower of Cost or Market • directly to each item • to each category • to the total inventory Frozen Spinach $80,000 $104,000 Carrots 100,000 90,000 Cut beans 50,000 40,000 Total frozen $230,000 $234,000 Canned Peas $90,000 $48,000 Mixed veget 95,000 92,000 Total canned $185,000$140,000 Total $415,000 $374,000

  4. Merch Inv Purchases CGS 5,800 0 0 Recording Inventory at Market • Beg Inventory: $6,000 cost, $5,800 market • End Inventory: $6,300 cost, $5,700 market Direct Method (w/ periodic inventory) 62,400

  5. Allow to Inv 200 Merch Inv Purchases CGS 6,000 0 0 Allowance Method (w/ periodic inventory) 62,400 To adjust inventory and record CGS: To adjust inventory and record CGS:

  6. Allow to Inv Merch Inv Merch Inv 200 6,000 5,800 400 5,800 6,000 Loss: decline CGS CGS 600 5,700 6,300 0 0 0 5,700 6,300 62,500 62,100 400 Direct Method Allowance Method

  7. VALUATION BASES Valuation at Net Realizable Value • permitted in some cases • certain minerals and agricultural products • even if NRV is above cost Purchase Commitments • agreement to buy inventory in the future • no asset or liability is recorded • loss recorded if market price drops below contract price

  8. Total Sales Price $40,000 $35,200 $75,200 Cost Allocated $50,000 Valuation Using Relative Sales Value Allocate $50,000 cost of production to joint products. Cashews Cashew pieces Qnty 5 tons 8 tons Sales Price / lb $4.00 $2.20 Relative Sales Price

  9. GROSS PROFIT METHOD (ESTIMATING INVENTORY) Unknown Estimate this and work backwards. Sales $780,000 Cost of Sales Beg inventory $ 34,000 Purchases 599,000 Goods available $633,000 End inventory . Cost of Goods Sold . Gross Profit 25%

  10. RETAIL INVENTORY METHOD Cost Retail Beg inventory $ 300 $ 600 Purchases 3,200 6,000 Goods available $3,500 $6,600 Add: Markups . 600 Adj. goods avail $3,500 $7,200 Sales 5,800 End inventory @ retail $1,400 End inventory @ cost

  11. Purchases @ Cost Purchases @ Retail 11/1 Purchase 10 units $60 $100 11/15 Purchase 10 units $70 $100 Sales @ Retail 11/10 Sell 8 units $80 11/25 Sell 4 units $40 Ending inventory (8 units)

  12. Purchases @ Cost Purchases @ Retail 11/1 Purchase 10 units $60 $100 11/15 Purchase 10 units $70 $100 11/21 Mark-up 12 units $12 Sales @ Retail 11/10 Sell 8 units $80 11/25 Sell 4 units $44 Ending inventory (8 units)

  13. Purchases @ Cost Purchases @ Retail 11/1 Purchase 10 units $60 $100 11/15 Purchase 10 units $70 $100 11/21 Mark-down 12 units ($24) Sales @ Retail 11/10 Sell 8 units $80 11/25 Sell 4 units $32 Ending inventory (8 units)

  14. Cost Retail Beg inventory $ 300 $ 600 Purchases 3,200 6,000 Goods available $3,500 $6,600 Deduct: Markdowns . 700 Adj. goods avail $3,500 $5,900 Sales 4,800 End inventory @ retail $1,100 End inventory @ cost

  15. Conventional Retail Inventory Method • Adjust the price of goods available by • adding markups • subtracting markdowns • Use the price after markups but before markdowns to determine the cost-to-retail ratio Special Items • Purchase returns: adjust both cost and retail value • Purchases discounts: adjust cost only • Sales net of returns but not net of discounts

  16. Purchases @ Cost Purchases @ Retail Purchase returns Purchase discounts Freight costs Sales @ Retail Sales & Shortages Sales returns & allow Sales discounts Employee discounts Shortages (breakage, theft) Ending Inventory

  17. INVENTORY DISCLOSURE AND ANALYSIS Inventory Turnover = Cost of Goods Sold Average Inventory • Required inventory disclosures • composition • financing arrangements • inventory valuation methods • Change in valuation method must be explained • Ratio for evaluating inventories:

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