Valuation and Reporting of
Receivables and Inventory
Chapter 6
Uncollectible Receivables

The matching principle requires that the
expense related to uncollectible receivables
must be recorded in the same period as the
related revenue

Often requires an estimate of uncollectible
receivables

Sale may be made in one period, but the uncollectible
receivable is not identified until a later period
Uncollectible Receivables

Balance sheet presentation requires reporting
of the estimated value of the receivables that
will be collected (net realizable value)

An allowance for doubtful accounts is used to
estimate the amount of receivables that will not be
collected


Usually do not know which receivables will be
uncollectible
The allowance is offset against the receivable
account
Uncollectible Receivables

Estimation methods


Percent of sales method

Bad debt expense is calculated as a percent of credit
sales made during the period

The expense increases the allowance for doubtful
accounts
Percent of receivables method

The required allowance for doubtful accounts is
calculated as the percent of receivables that are
expected to be uncollectible (aging)

Bad debt expense is the amount required to bring the
allowance up to its required balance
Uncollectible Receivables

Recording bad debt expense at year-end
increases the allowance account and reduces
retained earnings


It does not affect accounts receivable
Writing off a customer’s account reduces
accounts receivable and the allowance

It does not affect bad debt expense

Net realizable value of receivables is the same
after the writeoff as it was before
Valuation of Inventory

Inventory valuation relies on estimates since
it is often impossible to determine exactly
which goods have been sold and which
remain in inventory

Cost flow assumptions

Specific identification

Weighted average

First-in, first-out (FIFO)

Last-in, first-out (LIFO)
Valuation of Inventory

Specific identification

Can specifically identify which goods remain, and
match them to their cost


No estimate is needed
Weighted average cost

Determine the average cost of all goods available
for sale

Total cost / total units
Inventory Valuation

First-in, first-out

Assumes oldest goods are sold first, newer ones
remain in inventory

Assigns the oldest costs to the income statement


May understate cost of merchandise sold
Assigns the newest costs to the balance sheet

Provides good estimate of replacement cost of inventory
Inventory Valuation

Last-in, first-out

Assumes newest goods are sold first, oldest ones
remain in inventory

Assigns most recent costs to the income
statement


Good matching of cost to revenue, except when old
units are sold
Assigns oldest costs to balance sheet

May understate inventory value
Inventory Valuation

Example
Date
1-Jan
12-Apr
8-Jun
6-Aug
23-Sep
16-Nov
Inventory
Purchase
Purchase
Purchase
Purchase
Purchase
Units
50
60
80
70
90
50
400
Unit cost Total cost
$
6.00 $
300
6.20
372
6.40
512
6.60
462
6.80
612
7.00
350
$ 2,608
The ending inventory consists of 110 units
Inventory Valuation

Weighted average cost

$2,608 / 400 units = $6.52 per unit

Ending inventory


110 units @ $6.52 = $717.20
Cost of merchandise sold

290 units @ $6.52 = $1,890.80
Inventory Valuation

First-in, first-out

Ending inventory
16-Nov
23-Sep

50
60
110
$
7.00
6.80
$
$
350
408
758
Cost of merchandise sold
1-Jan
12-Apr
8-Jun
6-Aug
23-Sep
50
60
80
70
30
290
$
6.00
6.20
6.40
6.60
6.80
$
300
372
512
462
204
$ 1,850
Inventory Valuation

Last-in, first-out

Ending inventory
1-Jan
12-Apr

50
60
110
$
6.00
6.20
$
$
300
372
672
Cost of merchandise sold
8-Jun
6-Aug
23-Sep
16-Nov
80
70
90
50
290
$
6.40
6.60
6.80
7.00
$
512
462
612
350
$ 1,936
Inventory Valuation

Lower of cost or market rule


Inventory is reported at cost unless

The replacement cost is below the recorded cost, or

The items cannot be sold at their normal selling price
Cost, as determined by one of the cost flow
assumptions, is compared to the market value

Whichever is lower is the amount reported on the
financial statements

Avoids overstating the value of inventory