illustration 9-1 lcm inventory valuation - · pdf filecopyright © 1998 john wiley & sons,...

Copyright 1998 John Wiley & Sons, Inc. Kieso/Intermediate 9e
ILLUSTRATION 9-1LCM INVENTORY VALUATION
64
APPLICATION OF LOWER OF COST OR MARKET
CEILING
Net RealizableValue (NRV)
Replace-mentCost
Select the Middle Value
DesignatedMarketValue
COST
STEP 1:Determine theDesignatedMarket Value
STEP2: Select the Lower of Cost or Designated Market Value
Balance Sheet Inventory Value
NET REALIZABLE VALUE (NRV)-estimated selling price less costs of completion and disposal (covers obsolete, damaged and shopworn goods).
NRV LESS NORMAL PROFIT MARGIN-generally measured as a percentage of selling price (represents achievable gross profit even if replacement cost is lower.)
NRV prevents overstatement of inventory and understatement of current period loss;
NRVNPM prevents understatement of inventory and overstatement of current loss.
NRVNormalProfit Margin
FLOOR

ILLUSTRATION 9-1 (continued)
65
SITUATION A
COST$30
NetRealizable
Value$40
ReplacementCost$35
NRV LessNormal Profit
$20
MarketValue$35
Balance Sheet Inventory Value = $30
SITUATION B
COST$30
NetRealizable
Value$40
ReplacementCost$18
NRV LessNormal Profit
$20
MarketValue$20
Balance Sheet Inventory Value = $20

ILLUSTRATION 9-2THE GROSS PROFIT METHOD
66
THE GROSS PROFIT METHOD
There is one general approach to estimating the cost of ending inventory using thegross profit method. It makes use of the gross profits on sales. If given the markupon cost, compute the gross profit on sales.
Assume that the following information is given:
Beginning inventory $ 60,000 Purchases 90,000 Sales 100,000 Markup on cost 25%
You are to use the gross profit method to solve for the cost of ending inventory.
1. Compute gross profit on sales (if not given):
Gross profit on Sales =
= = = 20%
2. Compute cost of goods sold:
Cost of Goods Sold = Sales (100 % Gross profit on Sales) = $100,000 (100% 20%) = $100,000 80% = $80,000
3. Compute estimated cost of ending inventory:
Cost of beginning inventory $ 60,000 Cost of purchases + 90,000
+ Cost of goods available for sale 150,000 Cost of goods sold 80,000
Estimated cost of ending inventory $ 70,000
Markup on cost100% + Markup on cost
25%100% + 25%
25%125%

ILLUSTRATION 9-3NUMERICAL EXAMPLE OF THE GROSS PROFIT AND CONVENTIONAL RETAIL METHODS
67
Assume that the following information is given:
Beginning Inventory Net Sales at Retail $280,000 At Cost $ 100,000 Average Cost per Unit $ 8.00 At Retail 125,000 Average Selling Price per Unit $10.00Net Purchases At Cost $300,000 At Retail 360,000Net Markups 15,000Net Markdowns 10,000
GROSS PROFIT METHOD
Gross Profit Percentage = $2/$10 = 20%
Cost of goods sold = $280,000 (100% 20%) = $280,000 80% = $224,000Ending inventory = $100,000 + $300,000 $224,000 = $176,000
CONVENTIONAL RETAIL METHOD
Ending inventory at retail = $125,000 + $360,000 + $15,000 $10,000 $280,000 = $210,000
Cost-to-retail ratio = =
= 80%Ending inventory at average, LCM = 80% $210,000 = $168,000
$100,000 + $300,000$125,000 + $360,000 + $15,000
$400,000$500,000

ILLUSTRATION 9-4NUMERICAL EXAMPLE OF THE LIFO RETAIL METHODS
68
Assume the following information is given:
Beginning Inventory Net Sales at Retail $280,000 At Cost $100,000 Price Index At Retail 125,000 Beginning 100Net Purchases Ending 105 At Cost 300,000 Average Cost per Unit $8.00 At Retail 360,000 Average Selling Price per Unit $10.00Net Markups 15,000Net Markdowns 10,000
RETAIL LIFO (STABLE PRICES)
Ending inventory at retail= $210,000 (see above).
Cost-to-retail ratio = = .
= 82.19%
Ending inventory at LIFO cost = $169,862 (see below).
Cost RetailEnding inventory $210,000Beginning inventory $100,000 125,000New layer $ 85,000 At cost (82.19% $85,000) 69,862Ending inventory at LIFO $169,862
DOLLAR-VALUE LIFO RETAIL (FLUCTUATING PRICES)
Ending inventory at retail = $210,000Cost-to-retail ratio = 82.19% (see above).Ending inventory at dollar-value LIFO = $164,725 (see below). Cost RetailEnding inventory deflated ($210,000 1.05) $200,000Base layer $100,000 125,000
New layer $ 75,000 At cost (105% 82.19% $75,000) 64,725
Ending inventory at dollar-value LIFO $164,725
$300,000$360,000 + $15,000 $10,000
$300,000$365,000

ILLUSTRATION 9-5RELATIONSHIP BETWEEN LIFO RETAIL AND DOLLAR-VALUE LIFO
69
Exhibit 1Dollar-Value LIFO Data
Year 1 Year 2 Year 3 Year 4 Year 5(a) December 31 inventory priced at year-end (current) acquisition cost amounts $10,000 $10.920 $11,663 $11,880 $12,533
(b) Price index (wholesale) (Year 1 is base year) 1.00 1.04 1.07 1.10 1.12
(c) Inventories restated in base-year dollars (Line (a) line (b)) $10,000 $10,500 $10,900 $10,800 $11,200
(d) Increments in base-year dollars during Year number +$500 +$400 $100 +$400 2 3 4 5
Exhibit 2Retail LIFO Data
Year 1 Year 2 Year 3 Year 4 Year 5(e) December 31 inventory priced at year-end (current) retail amounts $15,000 $16,068 $17,066 $17,172 $17,334
(f) Price index (retail) (Year 1 is base year) 1.00 1.03 1.06 1.08 1.07
(g) Inventories restated in base-year retail dollars (Line (e) line (f)) $15,000 $15,600 $16,100 $15,900 $16,200
(h) Increments in base-year dollars during Year number +$600 +$500 $100 +$300 2 3 4 5
(i) Percentage of cost to sales price .60 .62 .58 .61 .65

ILLUSTRATION 9-5 (continued)
70
Legend
Exhibit 3Diagrammatic Presentation of Dollar-Value LIFO:
Data and Ending Inventory Calculations(Based on Exhibit 1 Data)
Year 1 Year 2 Year 3 Year 4 Year 5
$400 1.12
$448
$300 1.07
$321
$500 1.04
$520
$10,000
$300 1.07
$321
$500 1.04
$520
$10,000
$400 1.07
$428
$500 1.04
$520
$10,000
$500 1.04
$520
$10,000
$10,000
Layer:at base-year Indexat LIFO cost
Ending Inventory:(1) Stated at base-year dollars $10,000 $10,500 $10,900 $10,800 $11,200(2) Stated at Dollar-Value $10,000 $10,520 $10,948 $10,841 $11,289 LIFO
Exhibit 4Diagrammatic Presentation of Retail LIFO:
Data and Ending Inventory Calculations(Based on Exhibit 2 Data)
Year 1 Year 2 Year 3 Year 4 Year 5
$300 1.07
$300 1.06
$600 1.03
$500 1.06
$600 1.03
$600 1.03
Layer: Indexbase-year % cost toLIFO cost Sales
Ending Inventory:(1) Stated at base-year Retail $15,000 $15,600.00 $16,100.00 $15,900.00 $16,200.00(2) Stated at Retail LIFO $ 9,000 $ 9,383.16 $ 9,690.56 $ 9,567.60 $ 9,776.25
$300 1.06
$600 1.03
Source: A Jay Hirsch, "Dollar-Value and Retail LIFO: A Diagrammatic Approach," The Accounting Review, (October, 1969), pp. 840842.
$10,000 1.00 $10,000 1.00 $10,000 1.00 $10,000 1.00 $10,000 1.00
$208.65 .65
$307.40
.58 $184.44 .58 $184.44 .58
$383.16 .62$383.16 .62$383.16 .62$383.16 .62
$15,000 1.00 $15,000 1.00 $15,000 1.00 $15,000 1.00 $15,000 1.00
$ 9,000 .60 $ 9,000 .60 $ 9,000 .60 $ 9,000 .60 $ 9,000 .60

ILLUSTRATION 9-6SUMMARY OF INVENTORY VALUATION STANDARDS
71
In 1953, the AICPA published in revised and rewritten final form tenstatements related to inventory valuation that today still represent thebasic accounting standards for the valuation and reporting of inventories.These standards are quoted below:
STATEMENT 1. The term inventory is used herein to designate theaggregate of those items of tangible personal property which (1) areheld for sale in the ordinary course of business, (2) are in process ofproduction for such sale, or (3) are to be currently consumed in the production of goods or services to be available for sale.
STATEMENT 2. A major objective of accounting for inventories is theproper determination of income through the process of matchingappropriate costs against revenues.
STATEMENT 3. The primary basis of accounting for inventories iscost, which has been defined generally as the price paid orconsideration given to acquire an asset. As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location.
STATEMENT 4. Cost for inventory purposes may be determinedunder any one of several assumptions as to the flow of cost factors(such as first-in first-out, average, and last-in first-out), the majorobjective in selecting a method should be to choose the one which, under the circumstances, most clearly reflects periodic income.
STATEMENT 5. A departure from the cost basis of pricing the inventory is r

illustration 9-1 lcm inventory valuation - · pdf filecopyright © 1998 john wiley & sons,...

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