Inventory – Other Issues

Key Things To Know

 

Lower of Cost or Market (LCM):

Inventory cannot be reported at a value greater than future probable benefit from selling the asset.

Report a loss in value in the period the loss occurs (or is identified) and not in the period inventory is sold

Use LCM to determine the amount of lost value:

Inventory cannot be valued higher than the net cash flows or lower thanthe cost that gives a normal profit

Cost: Historical cost of inventory items using FIFO, LIFO, Ave cost, etc.

“Market”:
The middle amount of the following 3 terms (if LIFO)
or
Net Realizable Value (if FIFO or average cost):

Replacement cost: The current purchase price to replace the item

Net Realizable Value (NRV)
(can’t be higher than “ceiling”):

NRV = selling price less cost to dispose/sell

NRV less Normal Profit Margin
(can’t be lower than “floor”).

LCM when using LIFO method: Determine “market”

Determine “Replacement cost”, “NRV”, and “NRV – Profit”
The middle amount considered “Market”

Compare “Market” to “Cost”: the lowest amount is LCM
Compare “LCM” to “Cost”: when cost is higher, write down to LCM

Write inventory down to market:

CGS
         Inventory

or

Inventory Loss
             Allowance for Inventory Loss

LCM can be applied to individual items, groups of items, or to total inventory

Individual:
Determine “market” for each item.
Compare market and cost for each item
Put the lowest amount in the LCM column.

Each item will have an amount in the LCM column
Total the LCM column and compare to total cost.

Groups:
Total each of the 3 market items for each group
Determine a market for each group only.
Compare the market for the group to total cost for each group
Put the lowest in the LCM column.

The amounts in the LCM column will be a total for each group.
Total the amounts in the LCM column and compare to total cost.

Total:
Determine the total for each of the three categories
Determine the “market” for the total only.
Compare the total for the market to the total cost.
Put the lowest total amount in the LCM column.

The amount in the LCM column will be a total amount only (no items or groups)
Compare total LCM to the total cost total

LCM when using FIFO or Average: Net Realizable Value is “market”

Initially value inventory at cost using FIFO or average cost
      (NOT LIFO or retail inventory method).

Net Realizable Value = Sales Price – Cost to Sell

Compare cost to net realizable value and adjust inventory down to net realizable value if net realizable value is lower.

Apply to individual items, groups, or in total

The journal entry to reduce inventory to probably future economic benefit (market) is the same as for Lower of Cost or Market.

Use the “Gross Profit Method” to estimate the $ value of Inventory when:
1) Use the periodic method
2) No physical count is done

Gross Profit Method:

The following information must be provided:

BI
+ Purchases
1^st = GAS
– EI        
= CGS

Sales
– CGS       Plug
= GP        2^nd, compute sales x GP%, plug to get CGS, put above

3^rd: GAS – Estimated CGS = Estimated ending inventory at cost

The purpose of the Gross Profit Method is to estimate the value of ending inventory to be reported on the balance sheet.

Retail Inventory Method: Cost column and Retail column

Enough information is known to determine ending inventory at retail.
Ending inventory is reported at cost (which you do not know) and must estimate

Ending inventory at retail x the cost to retail ratio = ending inventory at cost

Typical Set-Up for determining ending inventory using the “Retail Inventory Method”:

Multiply the retail inventory value by the ratio to determine the estimated cost of inventory at the end of the period.

4 methods used for the “Retail Inventory Method”:

Average:
Includes net markups and markdowns in goods available for sale
(Compute the same as the example above)

LCM (Conventional):
Goods available for sale does not include markdowns
Move markdowns below good available for sale before computing the ratio

FIFO:
Cost to retail ratio does not include beginning inventory.
Remove beginning inventory from both cost and retail before computing the ratio

LIFO:
Compute a ratio for Beginning Inventory (BI)
Compute a ratio for this period only (same as FIFO)

Retail beginning inventory is valued at cost using a ratio of BI only
The rest of retail inventory is valued at cost using the FIFO ratio

Retail Column only:

Cost Column Only:

Both Cost and Retail Column:

Dollar Value LIFO (DVL):

LIFO means that first inventory purchases are still on the shelf
A company must keep all old invoices for each purchase in order to determine the cost of inventory at first purchase cost.

To make this more practical, FASB allows the inventory to be valued using a price index rather than the actual original purchase price.

A company begins using DVL in the base year, with a price index of 1.0
A price index is used for each year to determine the purchase cost during that year
All purchases in each year are considered to be one purchase (layer)

1^st Count the inventory and value it at last cost (FIFO)

2^nd Divide last cost by the price index to determine the first cost (LIFO)

3^rd Show the first cost in layers: Beginning, 1st year, 2nd year, etc.

4^th Multiply the first cost for each layer by the price index for each level

5^th Add up the totals for each layer and report this amount as ending inventory
on the balance sheet