Inventory – Other Issues
Key Things to Know
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.
The middle amount of the following 3 terms (if LIFO)
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:
Allowance for Inventory Loss
LCM can be applied to individual items, groups of items, or to total inventory
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.
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.
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
lower of cost or NRV
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:
|GP / Sales = GP %||(Estimated historical rate)|
|1st:||Calculate goods available for sale (GAS) (beginning inventory + purchases)|
|2nd:||Compute CGS by taking sales x GP% to get GP and back into CGS|
|3rd:||GAS less CGS = EI (at cost) Cost is what is reported on the balance sheet.|
1st = GAS
– CGS Plug
= GP 2nd, compute sales x GP%, plug to get CGS, put above
3rd: 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”:
|+ Freight In||X|
|– Purchase returns||X||X|
|– Purchase discounts||X|
|+ Mark ups||X|
|– Mark up cancellations||X|
|– Mark downs||X|
|+ Mark down cancellations||X|
|– Abnormal Spoilage||X||X|
|= Goods Available for Sale||X divided by||X||Ratio|
|– Normal Spoilage||X|
|+ Sales Returns||X|
|+ Employee Discounts||X|
|= Ending Inventory value||?||X|
|Ratio = Cost Goods Available for Sale
Retail Goods Available for Sale
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”:
Includes net markups and markdowns in goods available for sale
(Compute the same as the example above)
Goods available for sale does not include markdowns
Move markdowns below good available for sale before computing the ratio
Cost to retail ratio does not include beginning inventory.
Remove beginning inventory from both cost and retail before computing the ratio
|Cost GAS – Cost Beginning Inventory = Ratio
Retail GAS – Retail Beginning Inventory
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:
|Mark-up||Original selling price increase|
|Mark-up cancellation||Reduce selling price after being marked up|
|Mark-down||Original selling price decrease|
|Mark down cancellation:||Increase selling price after being marked down|
|Employee Discounts||Added to sales below goods available for sale|
|Sales returns/allow||Deducted from sales below goods available for sale|
|Normal spoilage||Deduct from retail below goods available for sale|
Cost Column Only:
|Freight-in||Add to the cost of inventory|
|Purchase discounts/allow||Decrease the cost of inventory|
Both Cost and Retail Column:
|Beginning Inventory||1st number in each column|
|Purchases||Add to beginning inventory|
|Purchase returns||Decrease inventory above goods available for sale|
|Abnormal spoilage||Decrease inventory above goods available for sale|
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)
1st Count the inventory and value it at last cost (FIFO)
2nd Divide last cost by the price index to determine the first cost (LIFO)
3rd Show the first cost in layers: Beginning, 1st year, 2nd year, etc.
4th Multiply the first cost for each layer by the price index for each level
5th Add up the totals for each layer and report this amount as ending inventory
on the balance sheet
Index = Value of EI