Inventory – Other Issues
Practice As You Learn
Practice as You Learn
Practice Problem 1 – Lower of Cost or Market
Information related to all the company’s products is provided below.
Normal gross profit on all products is 20% of cost.
| Product |
Replacement Cost |
NRV | Cost |
| A | 1,200 | 1,620 | 1,000 |
| B | 1,800 | 1,980 | 1,600 |
| C | 1,900 | 2,250 | 1,900 |
| D | 700 | 800 | 1,300 |
1. Determine the amount that inventory will be reported on the balance sheet using Lower of Cost or Market method:
A. By individual product
B. Group products A and B and group products C and D
C. In total for the company
2. Determine the amount that inventory will be reported on the balance sheet using Lower of Cost or Net Realizable Value Method:
A. By individual product
B. Group products A and B and group products C and D
C. In total for the company
Answer
1st Set up a table that allows you to compare the 3 “market” prices and determine market.
2nd Compare cost to market and select the lower of cost or market (LCM)
3rd Compare cost to LCM and determine if there is a necessary write-down
1. A. By Individual Product: LCM by individual product
| Product |
Replacement |
(Ceiling) NRV |
(Floor) NRV – Profit ** |
(Middle) Market |
Cost | LCM |
| A | 1,200 | 1,620 | 1,420 | 1,420 | 1,000 | 1,000 |
| B | 1,800 | 1,980 | 1,660 | 1,800 | 1,600 | 1,600 |
| C | 2,500 | 2,250 | 1,870 | 2,250 | 1,900 | 1,900 |
| D | 700 | 800 | 540 | 700 | 1,300 | 700 |
| Total | 5,800 | 5,200 |
** Profit = 20% of cost A = 200 B = 320 C = 380 D = 260
LCM is lower than cost by 600 so adjust inventory down to LCM
| Loss on market value (CGS) 600 Inventory 600 |
1. B. By Group, A& B, C&D: LCM by group of products
| Product | Replacement Cost |
(Ceiling) NRV |
(Floor) NRV – Profit ** |
Market | Cost | LCM |
| A | 1,200 | 1,620 | 1,420 | 1,000 | ||
| B | 1,800 | 1,980 | 1,660 | 1,600 | ||
| Group | 3,000 | 3,600 | 3,080 | 3,080 | 2,600 | 2,600 |
| C | 2,500 | 2,250 | 1,870 | 1,900 | ||
| D | 700 | 800 | 540 | 1,300 | ||
| Group | 3,200 | 3,050 | 2,410 | 3,050 | 3,200 | 3,050 |
| Total | 5,800 | 5,650 | ||||
Important: “market” and “LCM” is for group totals ONLY.
LCM is lower than cost by 150 so inventory must be adjusted down to LCM
| Loss on market value (CGS) 150 Inventory 150 |
1.C. In Total: LCM for the total only
| Product | Replacement Cost |
(Ceiling) NRV |
(Floor) NRV – Profit ** |
Market | Cost | LCM |
| A | 1,200 | 1,620 | 1,420 | 1,000 | ||
| B | 1,800 | 1,980 | 1,660 | 1,600 | ||
| C | 2,500 | 2,250 | 1,870 | 1,900 | ||
| D | 700 | 800 | 540 | 1,300 | ||
| Total | 6,200 | 6,650 | 5,490 | 6,200 | 5,800 | 5,800 |
Important:
Total each of the 3 items that could be market and select the middle amount to be the “market”.
Only the total amount is in the “market” and “LCM” column.
LCM is higher than or equal to cost so inventory is not adjusted.
2. A. By Individual Product: Lower of Cost or NRV by individual product
| Product | Cost | NRV | L of C or NRV |
| A | 1,000 | 1,620 | 1,000 |
| B | 1,600 | 1,980 | 1,600 |
| C | 1,900 | 2,250 | 1,900 |
| D | 1,300 | 800 | 800 |
| Total | 5,800 | 5,300 |
L of C or NRV is lower than cost by 500.
Adjust inventory down to LCM
| Loss on market value (CGS) 500 Inventory 500 |
2. B. By Group, A& B, C&D: Lower of Cost or NRV by group of products
| Product | Cost | NRV | L of C or NRV |
| A | 1,000 | 1,620 | |
| B | 1,600 | 1,980 | |
| Subtotal | 2,600 | 3,600 | 2,600 |
| C | 1,900 | 2,250 | |
| D | 1,300 | 800 | _________ |
| Subtotal | 3,200 | 3,050 | 3,050 |
| Total | 5,800 | 5,650 |
L of C or NRV is lower than cost by 150, adjust inventory down to LCM
| Loss on market value (CGS) 150 Inventory 150 |
2.C. In Total: L of C and NRV for the total only
| Product | Cost | NRV | L of C or NRV |
| A | 1,000 | 1,620 | |
| B | 1,600 | 1,980 | |
| C | 1,900 | 2,250 | |
| D | 1,300 | 800 | |
| 5,800 | 6,650 | 5,800 |
No adjustment to inventory: Cost = L of C or NRV
Practice Problem 2 – Gross Profit Method
The following information was taken from the records of the Company for the period from January 1st to September 30th:
| Sales | 2,500,000 |
| Beginning Inventory | 420,000 |
| Purchases | 2,150,000 |
| Freight-in | 115,000 |
| Purchase Returns | 40,000 |
| Selling Expense | 450,000 |
| Depreciation Expenses | 110,000 |
The company sells it products to earn 40% gross profit.
Use the gross profit method to estimate the value of ending inventory on September 30th.
Answer
1st: Calculate goods available for sale (GAS)
(beginning inventory + all purchase related accounts)
2nd: Compute CGS by multiplying 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.
| Beginning Inventory | 420,000 |
| + Purchases | 2,150,000 |
| + Freight-In | 115,000 |
| + Purchase Returns | (40,000) |
| = Available | 2,645,000 |
| – CGS (see below) | 1,500,000 |
| = Ending Inventory | 1,145,000 |
| Sales | 2,500,000 |
| – CGS must be | 1,500,000 plug |
| = GP / Sales = GP 40% | 1,000,000 |
Important: Ignore all operating expenses when using the gross profit method to estimate the value of inventory.
Practice Problem 3 – Retail Inventory Method
The following data is available for the company for the current year:
| Sales | 211,000 | Sales Discounts | 12,000 | |
| Markups, net | 17,000 | Markdowns, net | 15,000 | |
| Freight In | 6,000 | Purchases, cost | 122,000 | |
| Purchases, retail | 185,000 | Freight out | 10,000 | |
| Beginning Inventory, cost | 153,000 | Normal Spoilage | 11,000 | |
| Beginning Inventory, retail | 233,000 | Employee Discounts | 5,000 |
Compute the estimated value of ending inventory using the retail inventory method and
A. Average Cost
B. Lower of Cost or Market
C. FIFO
D. LIFO
Answer
1st Set up the format using average cost.
| Cost | Retail | ||
| Beginning Inventory | 153,000 | 233,000 | |
| + Purchases | 122,000 | 185,000 | |
| + Freight In | 6,000 | ||
| + Markups, net | 17,000 | ||
| – Markdowns, net | (15,000) | ||
| = Available (66.9%) | 281,000 | / | 420,000 |
| – Sales | (211,000) | ||
| + Sales Discounts | 12,000 | ||
| – Employee Discounts | ( 5,000) | ||
| – Normal Spoilage | (11,000) | ||
| = Ending Inventory | ???? | 205,000 |
Important:
Ending Inventory at Retail is the same for all method
A. Average cost:
| Retail Ending Inventory 205,000 x Cost to Retail % 0.669 = Ending Inventory at Cost 137,145 |
B. Lower of Cost or Market (Conventional):
Do not rewrite the entire calculation. Adjust from average to lower of cost or market:
| Available at Average Cost – retail | 420,000 |
| + Markdowns, net | 15,000 |
| Available at Lower of Cost or Market –retail | 435,000 |
Then compute the cost to retail percentage
| Available at Cost 281,000 = 0.646 Available at Retail 435,000 |
| Ending Inventory at Retail 205,000 x Cost to Retail % 0 .646 = Ending Inventory at Cost 132,430 |
C. FIFO Do not include beginning inventory (assume BI was sold)
Compute the cost to retail % excluding beginning inventory using the average setup
| Cost Available – Cost Beg. Inventory Retail Available – Retail Beg. Inventory |
| 281,000 – 153,000 = 128,000 = 0.685 420,000 – 233,000 = 187,000 |
| Ending Inventory at Retail 205,000 x Cost to Retail % 0.685 = Ending Inventory at Cost 140,425 |
D. LIFO use the average format
1st determine whether ending inventory is from beginning inventory or current period purchases
Put in the beginning inventory for each and the current period layer for each
| Retail Cost
Beginning Inventory 233,000 153,000 |
Use the FIFO cost/retail % of 0.685
The normal procedure is to multiply the current layer by the FIFO % and put the number in the cost column, than add the two layers together to get the total value of ending inventory at cost using LIFO.
Since the current period layer is negative there is none left that was purchased during the current period.
All ending inventory is from the beginning inventory layer.
Value ending inventory using the beginning inventory cost to retail % of .657 (153,000 / 233,000)
| Ending Inventory at Retail 205,000 x Cost to Retail % .657 = Ending Inventory at Cost 134,685 |
The company uses the FIFO method to value inventory and reports ending inventory using dollar value LIFO. At the end of each year it converts the FIFO value to dollar value LIFO. The following information is available:
| FIFO $ | Inflation Index | |
| Base Year | 200,000 | 1.00 |
| End of Year 1 | 260,000 | 1.08 |
| End of Year 2 | 239,000 | 1.15 |
| End of Year 3 | 280,000 | 1.12 |
Calculate the value of ending inventory using dollar value LIFO for all years given.
Answer
Inventory at last cost is often called FIFO inventory. Divide the last cost by the inflation index to get to inventory at first cost. Then determine which layer the first cost inventory is from, beginning with the first base layer. Multiply the amount related to the layer by the inflation index for the layer to get the value of inventory back to first cost.
| Inventory at Price Inventory at Price Date Last Cost / Index = First Cost From Index = Value of EI Base 200,000 1.0 200,000 200,000 x 1.0 200,000 Year 1 260,000 1.08 240,741 200,000 x 1.0 200,000 Year 2 239,000 1.15 207,826 200,000 x 1.0 200,000 Year 3 280,000 1.12 250,000 200,000 x 1.0 200,000 |
Important to notice:
For year 3, there is no inventory left that was purchased in year 2.
The inflation index of 1.15 will never be used since there is no inventory left from this purchase year layer.