HIGHLIGHTS OF CHAPTER 9:
Additional Issues
March 2004
SIGNIFICANT ISSUES
Lower of cost or market
Gross profit method
Retail method
Dollar-value retail method
Change in inventory method
Correction of error
Purchase commitments
LOWER OF COST OR
MARKET
Principle of conservatism
Replacement cost v NRV
Applying floor & ceiling
Designated market value v Cost
3 application approaches
FLOOR & CEILING
Ceiling - Net Realizable Value
Replacement cost
Floor - NRV less normal profit
APPLYING RULE
Ceiling:
Sales price
Cost to complete
NRV
Floor:
NRV
Normal profit
NRV less profit
1,200
100
1,100
1,100
120
980
APPLYING RULE
Cost
1,000
Ceiling - NRV
1,100
Replacement cost
950
Floor - NRV less profit
980
Designated market value
980
ALWAYS CHOOSE THE VALUE IN
THE MIDDLE
THREE APPROACHES
Item by item
By group
Entire inventory
GROSS PROFIT METHOD
Estimate ending inventory
Based on normal gross profits
Only an estimate!
GROSS PROFIT METHOD
Beginning inventory (at cost)
Purchases (at cost)
Total goods available for sale
Sales (at selling price)
$280,000
Less: Gross profit at 30% 84,000
Sales (at cost)
Estimated inventory (at cost)
$60,000
200,000
260,000
196,000
$64,000
GROSS PROFIT RATIO
% of sales
Alternative is markup on cost
-Stated as % of cost
Cost
$100
Gross profit
50
Markup on cost
50%
RETAIL METHOD
COST
$1,000
30,000
600
(1,500)
RETAIL
Beginning inventory
$1,800
Purchases
60,000
Freight-in
Purchase returns
(3,000)
Net mark-ups
9,000
Abnormal shortages
(1,200)
(2,000)
Total
$28,900
$65,800
Cost-to-retail % = 28900/65800 = 43.9%
RETAIL METHOD
RETAIL
Total available for sale at retail
$65,800
Less: Net markdowns
1,400
Sales
$36,000
Sales returns
(900)
35,100
Employee discounts
800
Normal shortages
1,300
Ending inventory at retail
$27,200
Cost-to-retail %
43.9%
Ending inventory at cost
$11,941
LIFO RETAIL METHOD
COST
$27,000
346,500
Beginning inventory 2001
Purchases, net
Net mark-ups
Net mark-downs
_______
Total
$346,500
Net sales
Ending inventory 2001 at retail
RETAIL
$45,000
480,000
20,000
( 5,000)
$495,000
484,000
$ 56,000
2001 Cost-to-retail % (346,500/495,000) 70.0%
LIFO RETAIL METHOD
Ending inventory 2001 at retail
Layer
2000
2001
Retail
$45,000
11,000
$56,000
Cost-toretail %
60%
70%
$ 56,000
LIFO
Cost__
$27,000
_ 7,700
$34,700
DOLLAR-VALUE LIFO
COST
$27,000
346,500
Beginning inventory 2001
Purchases, net
Net mark-ups
Net mark-downs
_______
Total
$346,500
Net sales
Ending inventory 2001 at retail
RETAIL
$45,000
480,000
20,000
( 5,000)
$495,000
484,000
$ 56,000
2001 Cost-to-retail % (346,500/495,000) 70.0%
DOLLAR-VALUE LIFO
Ending inventory 2001 at retail
Price indexes:
2000
100%
2001
112%
$ 56,000
Ending inventory 2001 at retail deflated to baseyear prices (56,000 /112%)
$ 50,000
DOLLAR-VALUE LIFO
Ending inventory 2001 at retail
Ending inventory 2001 at base-year
Beginning inventory 2001 at base-year
Inventory increase at base-year prices
Price Cost-toLayer
Retail Index retail %
2000
$45,000 100%
60%
2001
5,000 112%
70%
$50,000
$ 56,000
$ 50,000
45,000
5,000
LIFO
Cost__
$27,000
_ 3,920
$30,920
DOLLAR-VALUE LIFO
Ending inventory 2002 at retail
Ending inventory 2002 at base-year
Beginning inventory 2002 at base-year
Inventory increase at base-year prices
Price Cost-toLayer
Retail Index retail %
2000
$45,000 100%
60%
2001
5,000 112%
70%
2002
4,000 120%
75%
$54,000
$ 64,800
$ 54,000
50,000
4,000
LIFO
Cost__
$27,000
3,920
_ 3,600
$34,520
CHANGE IN METHOD
Cumulative effect on prior
years included in current P/L
Change to LIFO reported on
prospective basis
Change from LIFO reported
on retroactive basis by
restating prior year statements
CORRECTION OF ERROR
Restating prior year statements
Record adjustments
EFFECT OF INVENTORY ERRORS
Beginning inventory
Ending inventory
Purchases
Cost of goods sold
Retained earnings
Following years
PURCHASE COMMITMENTS
Record loss when price
declines – not when sold
Record purchase at market
value
Loss on future purchases
creates a future estimated
liability