Inventory Valuation Issues
Sid Glandon, DBA, CPA
Associate Professor of Accounting
1
Lower of Cost or Market
Historical cost principle is violated
 Conservative approach

– Recognize loss in period incurred not the
period that the sale is made

Lower of cost or market
– The lesser of
• Cost, or
• Designated market
2
Designated Market

Replacement cost
– But not more than the CEILING
• net realizable value
– Selling price less cost of completion and disposal
– Or less than the FLOOR
• net realizable value less normal profit margin
3
Lower of Cost or Market

If designated market is lower, record the
loss using the
– Direct method
• Charge to inventory
– with the debit to cost of goods sold, or
– if material, loss on reduction to LCM
– Indirect method
• Charge an allowance account to reduce
inventory to market
4
Lower of Cost or Market
Designated Market Comparison
Item
A
B
C
D
Historical
Cost
Replacement
$80,000
$88,000
90,000
88,000
90,000
88,000
90,000
88,000
Selling Price
$150,000
125,000
125,000
108,750
Selling
Commission
$30,000
25,000
25,000
21,750
Ceiling
$120,000
100,000
100,000
87,000
Floor
$104,000
70,000
90,000
70,000
NRV
$120,000
100,000
100,000
87,000
Designated
Market
$104,000
88,000
90,000
87,000
Normal
Gross Profit
$16,000
30,000
10,000
17,000
Lower of
Cost or
Market
$80,000
88,000
90,000
87,000
NRV Normal
Gross Profit
$104,000
70,000
90,000
70,000
5
Lower of Cost or Market
Designated Market Comparison
Item
A
B
C
D
Historical
Cost
Replacement
$80,000
$88,000
90,000
88,000
90,000
88,000
90,000
88,000
$350,000
Ceiling
$120,000
100,000
100,000
87,000
Floor
$104,000
70,000
90,000
70,000
Designated
Market
$104,000
88,000
90,000
87,000
Lower of
Cost or
Market
$80,000
88,000
90,000
87,000
$345,000
6
Account
Debit
Credit
Cost of goods sold
$5,000
Inventory
$5,000
To record loss on inventory value as a result of write down to LCM
Analysis of charge to cost of goods sold:
Original cost
LCM
Cost of goods sold
$350,000
345,000
$5,000
7
Gross Profit Method
of Estimating Inventory

Assumptions
– Beginning inventory plus purchases equals
goods available for sale
– Goods not sold must be on hand
– Goods available for sale less cost of goods
sold (sales at cost) equals ending inventory
8
Gross Profit Method of Estimating Ending Inventory
Beginning inventory
Purchases
Cost of goods available for sale
Sales
Gross profit percentage
Gross profit
Cost of goods sold
Estimated ending inventory
Gross profit based on sales (40% of sales)
Sales
Cost of goods sold
Gross profit
$50,000
125,000
175,000
$112,000
40%
44,800
67,200
$107,800
$112,000
67,200
$44,800
% of Sales
100%
60%
40%
9
Analysis of Markups
Gross profit based on sales (40% of sales)
Sales
Cost of goods sold
Gross profit
Gross profit based on cost (40% of cost)
Sales
Cost of goods sold
Gross profit
% of Sales
$10,000
100%
6,000
60%
$4,000
40%
% of Cost
140%
100%
40%
% of Sales
$8,400
100%
6,000
71%
$2,400
29%
10
Gross Profit Method of Estimating Ending Inventory
Beginning inventory
Purchases
Cost of goods available for sale
Sales
Cost plus gross profit
Cost of goods sold
Estimated ending inventory
Gross profit based on cost (40% of cost)
Sales
Cost of goods sold
Gross profit
$50,000
125,000
175,000
$112,000
140%
80,000
$95,000
$112,000
80,000
$32,000
% of Cost % of Sales
140%
100%
100%
71%
40%
29%
11
Retail Inventory Method
Used in retail
 Assumes

– High volume of sales
– Different types of merchandise
– Observable pattern between cost and
prices
Determine ending inventory at retail
 Convert to cost basis

12
Conventional Retail Inventory Method
Cost
Beginning inventory
$2,000
Purchases (net)
10,000
Goods available
$12,000
Markups
$3,000
Markup cancellations
(1,000)
Net markups
Goods available, retail
Cost-to-retail ratio
Markdowns
Markdown cancellations
Net markdowns
Goods available, retail (net)
Sales (net)
Ending inventory at retail
Cost-to-retail ratio
Ending inventory at cost
12,000
20,000
Retail
$3,000
15,000
18,000
2,000
20,000
60%
2,500
(2,000)
500
19,500
(12,000)
7,500
60%
$4,500
13
Analysis of Inventory

Inventory turnover ratio
– Number of times on average the inventory
was sold during the period
– Calculated as
• Cost of goods sold ÷ Average inventory
14
Example: Inventory turnover ratio
Cost of goods sold = $1,440,000
 Beginning inventory = $150,000
 Ending inventory = $170,000

15
Example: Inventory turnover ratio
Cost of goods sold
Average inventory
Inventory turnover ratio
Analysis of average inventory:
Beginning inventory
Ending inventory
Total
Divided by
Average inventory
$1,440,000
$160,000
9.00
$150,000
170,000
$320,000
2
$160,000
16