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
Cost

(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
– Current period layer              (28,000)                        
= Ending Inventory                   205,000                ??

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
Practice Problem 4 – Dollar Value LIFO

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
                                                                                                plug      40,741  x   1.08              44,000
                                                                                                            240,741                          244,000

Year 2        239,000                  1.15                   207,826                200,000  x  1.0               200,000
                                                                                                plug        7,826  x  1.08                 8,452
                                                                                                            207,826                          208,452

Year 3       280,000                    1.12                  250,000               200,000  x  1.0               200,000
                                                                                                                7,826  x  1.08                 8,452
                                                                                                plug      42,174  x  1.12               47,235
                                                                                                            250,000                          255,687

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.