Intermediate Accounting
Eighteenth Edition
Kieso; Weygandt; Warfield
Chapter 8
Inventories: Additional Valuation Issues
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Copyright ©2022 John Wiley & Sons, Inc.
Learning Objectives
After studying this chapter, you should be able to:
1. Describe and apply the lower-of-cost-or-net realizable
value rule.
2. Describe and apply the lower-of-cost-or-market rule.
3. Identify other inventory valuation issues.
4. Determine ending inventory by applying the gross
profit method.
5. Determine ending inventory by applying the retail
inventory method.
6. Explain how to report and analyze inventory.
Copyright ©2022 John Wiley & Sons, Inc.
2
Preview of Chapter 8
Inventories: Additional Valuation Issues
Lower-of-Cost-or-Net Realizable Value
• Definition
• Illustration
• Methods of applying
• Adjusting to NRV
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3
Preview of Chapter 8
Lower-of-Cost-or-Market
• How LCM works
• Methods of applying LCM
• Evaluation of LCNRV and LCM
Other Valuation Approaches
• Net realizable value
• Relative sales value
• Purchase commitments
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4
Preview of Chapter 8
The Gross Profit Method of Estimating Inventory
• Computation of gross profit percentage
• Evaluation of gross profit method
Retail Inventory Method
• Concepts
• Conventional method
• Special items
• Evaluation
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5
Preview of Chapter 8
Presentation and Decision Analysis
• Presentation
• Decision Analysis
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Learning Objective 8.1
Describe and apply the lower-of-cost-or-net realizable
value rule.
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Lower-of-Cost-or-Net Realizable Value
A company abandons the historical cost principle
when the future utility (revenue-producing ability) of
the asset drops below its original cost.
Definition of Net Realizable Value
• Estimated selling price in the ordinary course of
business, less reasonably predictable costs of
completion, disposal, and transportation
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Definition of Net Realizable Value
Illustration
Assume that Starbucks Corporation has unfinished
inventory with a cost of $950, a sales value of $1,000,
estimated cost of completion of $50, and estimated selling
costs of $200. Starbucks net realizable value is computed
as follows.
Inventory value-(Estimated Selling Price)
$1,000
Less: Estimated cost of completion
$ 50
Estimated selling costs
200
Net realizable value
250
$ 750
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Definition of Net Realizable Value
LCNRV Disclosures
• Starbucks reports inventory at $750
• In its income statement, Starbucks reports a Loss
Due to Decline of Inventory to NRV of $200 ($950 −
$750)
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Illustration of LCNRV
Final Inventory Value
Whole Foods provides the following information related to its inventories.
Food
Cost
Net Realizable Value
Spinach
$ 80,000
$120,000
Carrots
100,000
100,000
Cut beans
50,000
40,000
Peas
90,000
72,000
Mixed vegetables
95,000
92,000
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Illustration of LCNRV
Determining Final Inventory Value—Whole
Foods
Food
Cost
Net Realizable Value
Final Inventory Value
Spinach
$ 80,000
$120,000
$ 80,000
Carrots
100,000
100,000
100,000
Cut beans
50,000
40,000
40,000
Peas
90,000
72,000
72,000
Mixed vegetables
95,000
92,000
92,000
$384,000
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Illustration of LCNRV
Explanation of Final Inventory Value—Whole
Foods
Final Inventory
Value
Spinach
Cost ($80,000) is selected because it is lower then
net realizable value.
Carrots
Cost ($100,000) is the same as net realizable value.
Cut beans
Net realizable value ($40,000) is selected because
it is lower than cost.
Peas
Net realizable value ($72,000) is selected because
it is lower than cost.
Mixed
Vegetables
Net realizable value ($92,000) is selected because
it is lower than cost.
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Method of Applying LCNRV
Alternative Applications of LCNRV
Companies usually price inventory on an item-by-item
basis.
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Cost-of-Goods-Sold and Loss Methods
Illustration: Ricardo Company reports the following
information related to its inventory.
Sales revenue
$200,000
Cost of goods sold (before NRV adjustment)
108,000
Ending inventory (at cost)
82,000
Ending inventory (at NRV)
70,000
a. What are the journal entries to adjust inventory to NRV using (1) the cost-of-goods-sold
method and (2) the loss method, assuming the use of the perpetual inventory system?
b. How should the income statement for Ricardo be reported if (1) the cost-of-goods-sold
method is used or (2) the loss method is used?
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Cost-of-Goods-Sold and Loss Methods
Adjust Inventory to NRV
a.
To adjust inventory to NRV:
Cost-of-Goods-Sold Method
Cost of Goods Sold
Inventory ($82,000 - $70,000)
Loss Method
Inventory Loss
12,000
12,000
Inventory ($82,000 - $70,000)
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12,000
12,000
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Cost-of-Goods-Sold and Loss Methods
Income Statements
b. 1. Cost-of-goods-sold method:
Sales revenue
$200,000
Cost of goods sold (after adjustment to NRV*)
120,000
Gross profit on sales
$ 80,000
2. Loss method:
Sales revenue
$200,000
Cost of goods sold
108,000
Gross profit on sales
92,000
Inventory loss
12,000
$ 80,000
*Cost of goods sold (before adjustment to NRV)
Difference between inventory at cost and NRV ($82,000 — $70,000)
Cost of goods sold (after adjustment to NRV)
Copyright ©2022 John Wiley & Sons, Inc.
$ 108,000
12,000
$120,000
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Put It into Practice LO 8.1 Determine
LCNRV
FACTS Gard Corporation has the following four items in its ending inventory.
Item
Cost
Selling Price
Costs to Complete and Sell
M
$2,000
$3,000
$900
N
5,000
8,000
3,050
O
4,400
6,000
1,375
P
3,200
5,000
1,170
INSTRUCTIONS
Determine the following.
a. The LCNRV for each item.
b. The amount of write-down, if any, using (1) an item-by-item LCNRV evaluation and (2)
total inventory LCNRV evaluation.
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Put It into Practice LO 8.1 Determine
LCNRV
Solution
a.
b.
The LCNRV for each item is presented as follows.
Item
Cost
NRV
LCNRV
M
$ 2,000
$ 2,100 ($3,000–$900)
$ 2,000
N
5,000
4,950 ($8,000 - $3,050)
4,950
O
4,400
4,625 ($6,000–$1,375)
4,400
P
3,200
3,830 ($5,000–$1,170)
3,200
Total
$14,600
$15,505
$14,550
1. On an item-by-item basis, the write-down is $50, which is due to the decline in NRV
for item N ($5,000 – $4,950).
2. There is no write-down when performing the assessment on the total inventory
($15,505 > $14,600).
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Learning Objective 8.2
Describe and apply the lower-of-cost-or-market
rule.
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Lower-of-Cost-or-Market
The use of the LCNRV method works well to measure
the decline in value of inventory for most companies.
FASB granted an exception to the LCNRV approach for
companies that use the LIFO or retail inventory
methods.
• Rather than comparing cost to net realizable value
companies compare a “designated market value” of
inventory to cost
• Approach is commonly referred to as lower-ofcost-or-market (LCM)
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Lower-of-Cost-or-Market
Two Limitations
This approach begins with replacement cost, then applies
two additional limitations to value ending inventory.
• Net realizable value (ceiling)
• Net realizable value less a normal profit margin (floor)
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Lower-of-Cost-or-Market
Net Realizable Value (NRV)
NRV is the estimated selling price in the ordinary
course of business, less reasonably predictable costs of
completion and disposal.
A company values inventory at the lower-of-cost-ormarket, with market limited to an amount that is not
more than net realizable value or less than net
realizable value less a normal profit margin.
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LCM Measures
Illustration: Parker Corp. has unfinished inventory with an
estimated selling price of $1,000, estimated cost of
completion and disposal of $300, and a normal profit
margin of 10% of sales.
The net realizable value and net realizable value less a
normal profit margin is calculated as follows:
Inventory— (based on estimated selling price)
$1,000
Less: Estimated cost of completion and disposal
300
Net realizable value
700
Less: Allowance for normal profit margin (10% of sales)
100
Net realizable value less a normal profit margin
Copyright ©2022 John Wiley & Sons, Inc.
$ 600
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Evaluation of Replacement Cost
Illustration: Assume that Costco paid $1,000 for an
infrared sauna that it can now purchase for $900. The
net realizable value of the sauna is $700.
Costco should use the $700 net realizable value as the
ceiling. This is the amount it could receive upon
disposal. To report the replacement cost of $900
overstates the ending inventory and understates the
loss for the period.
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Inventory Valuation-Lower-of-Cost-orMarket
Illustration:
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Computation of Designated Market
Value
Illustration:
Food
Replacement Cost
Net Realizable
Value (Ceiling)
Net Realizable Value Less a
Normal Profit Margin (Floor)
Designated
Market Value
Spinach
$ 88,000
$120,000
$104,000
$104,000
Carrots
90,000
100,000
70,000
90,000
Cut beans
45,000
40,000
27,500
40,000
Peas
36,000
72,000
48,000
48,000
Mixed vegetables
105,000
92,000
80,000
92,000
For each food category, the designated market value (in red) is the middle value among replacement cost, net
realizable value and net realizable value less a normal profit margin.”
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Final Inventory Value
Illustration: Refer to the Whole Foods information illustration.
Using the designated market values in Illustration 9.3, the final inventory value for
each food category is the lower value between cost and designated market value.
Food
Cost
Designated Market Value
Final Inventory Value
Spinach
$ 80,000
$104,000
$ 80,000
Carrots
100,000
90,000
90,000
Cut beans
50,000
40,000
40,000
Peas
90,000
48,000
48,000
Mixed vegetables
95,000
92,000
92,000
$415,000
Copyright ©2022 John Wiley & Sons, Inc.
$350,000
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Disadvantages of LCNRV and LCM
Rules
Illustration:
Major Disadvantages
Result
Mismatch in valuation
A company recognizes decreases in the value of the asset and the charge to expense in the
period in which the loss in utility occurs—not in the period of sale. On the other hand, it
recognizes increases in the value of the asset only at the point of sale. In other words, a
company may value the inventory at cost in one year and at market or NRV in the next year.
Mismatch in income
Net income for the year in which a company takes the loss is lower. Net income of the
subsequent period may be higher than normal if the expected reductions in sales price do
not materialize.
Use of estimates
Application of these rules uses “normal profit” or “ordinary” costs to sell or dispose in
determining inventory values. Since companies develop these estimates based on past
experience (which they may not attain in the future), this subjective measure presents an
opportunity for income manipulation.
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Put It into Practice LO 8.2 Determine
LCM
Part a.
FACTS Presented below is information related to Fowler Golf, Inc.’s inventory.
Assume Fowler uses LIFO and LCM.
Measurement
Golf Bags
Shoes
Rain Suits
Historical cost
$190.00
$106.00
$53.00
Selling price
212.00
145.00
73.75
Cost to complete
19.00
8.00
2.50
Current replacement cost
203.00
105.00
51.00
Normal profit margin
32.00
29.00
21.25
INSTRUCTIONS
Determine the following:
a. The ceiling and the floor that should be used in the lower-of-cost-or-market
computation for golf bags.
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Put It into Practice LO 8.2 Determine LCM
Parts b. and c. and Solution
b.
The designated market value that should be used in the lower-of-cost-or-market comparison for Shoes.
c.
The lower-of-cost-or-market for the rain suits.
SOLUTION
a.
The ceiling for golf bags is $193 (net realizable value), computed as follows.
Selling price
$212
Costs to complete
(19)
Ceiling
$193
The floor for golf bags is $161 (NRV less a normal profit margin), computed ted as follows.
b.
c.
NRV
$193
Normal profit margin
(32)
Floor
$161
The designated market value for shoes in $108 (net realizable value), determined as follows.
NRV (Selling price less costs to complete)
$137($145 – $8)
Designated market (NRV less normal profit margin)
$108 ($137 – $29)
Replacement cost
$105
The LCM for rain suits is $51.00 (replacement cost). It is the designated market value, which is less than the
historical cost of $53. The designated market value is determined as follows.
NRV (Selling price less costs to complete)
$71.25 ($73.75 – $2.50)
Designated market (Replacement cost)
$51.00
NRV less normal profit margin
$50.00 ($71.25 – $21.25)
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Learning Objective 8.3
Identify other inventory valuation issues.
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Other Valuation Approaches
Valuation at Net Realizable Value
Permitted by GAAP when all the following conditions
are met:
1) A controlled market with a quoted price applicable
to all quantities, and
2) No significant costs of disposal
3) The product is available for immediate delivery.
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Other Valuation Approaches
Relative Sales Value
Illustration: Woodland Developers purchases land for
$1 million that it will subdivide into 400 lots. Area A
has 100 lots, which will sell for $1,000,000 (100 ×
$10,000). Area B has 100 lots with a sales price of
$600,000 (100 × $6,000). Area C has 200 lots with a
sales price of $900,000 (200 × $4,500). The sales prices
across the areas vary based on the view afforded by
each lot of the adjacent lake. Area C has no view of the
lake, Area B has a partial view, and Area A has an
unobstructed view of the lake.
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Other Valuation Approaches
Cost per Lot Using Relative Sales Value Method
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Gross Profit Using Relative Sales Value
Illustration: Use the information about Woodland
Developers from the previous example. Woodland sold
77 Area A lots, 88 Area B lots, and 100 Area C lots.
How would you compute Woodland’s cost of lots sold
and gross profit?
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Gross Profit Using Relative Sales Value
Solution
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Other Valuation Approaches
Purchase Commitments—A Special Problem
• Purchase commitments are agreements to buy
inventory weeks, months, or even years in advance.
• Generally, the seller retains title to merchandise
• Buyer recognizes no asset or liability
• If contract price is greater than market price, and
the buyer expects losses will occur when purchase
occurs, buyer should recognize losses in period
when such declines in market prices take place
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Purchase Commitment
Illustration: Starbucks signed a contract to purchase
coffee beans in 2026 at a price of $10,000,000.
Assume further that the market price of the coffee
beans on December 31, 2025, dropped to $7,000,000.
Starbucks would make the following entries on
December 31, 2025 and March 30, 2026.
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Purchase Commitment
Solution
a.
To record the loss on the purchase commitment:
December 31, 2025
Loss on Purchase Commitments
3,000,000
Estimated Liability on Purchase
Commitments
3,000,000
Starbucks would report the loss in the income statement under “Other expenses and losses." And because the contract is to be
executed within the next fiscal year, Starbucks would report the Estimated Liability on Purchase Commitments in the current
liabilities section on the balance sheet.
b.
To record purchase of the inventory:
March 30, 2026
Purchases (Inventory)
7,000,000
Estimated Liability on Purchase
Commitments
3,000,000
Cash
10,000,000
The result of the purchase commitment was that Starbucks paid $10 million for a
contract worth only $7 million. It recorded the loss in the previous period—when
the price declined.
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Put It into Practice LO 8.3 Account for
Relative Sales Value, Purchase
Commitments
FACTS Remote, Inc. buys 500 USB speaker/microphone headsets from a distributor that is experiencing a
decline in demand for those products due to the growing popularity of Bluetooth technology. The purchase
price for the lot is $8,000. Bell will group the headsets into three price categories for resale, as indicated below.
Group
No. of Headsets
Price per Headset
1
50
$10
2
400
20
3
50
30
INSTRUCTIONS
a.
Determine the cost per headset for each group, using the relative sales value method.
b.
At December 31, 2025, Remote has outstanding noncancelable purchase commitments for 12,000 USB cords, at $2.00 per cord,
which is raw material for a variety of Remote’s products. The company prices its raw material inventory at cost or net realizable
value, whichever is lower.
1.
Assuming that the market price as of December 31, 2025, is $2.30 per cord, how would you report this matter in the
accounts and statements? Explain.
2.
Assuming that the market price as of December 31, 2025, is $1.70 per cord, instead of $2.30, how would you report this
situation in the accounts and statements?
3.
Give the entry in January 2026, when the cord shipment is received, assuming that the situation given in part (b2) existed
at December 31,2025, and that the market price in January 2026 is $1.70 per cord. Give an explanation of your
treatment.
Copyright ©2022 John Wiley & Sons, Inc.
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Put it Into Practice LO 9.3 Account for
Relative Sales Value and Purchase
Commitments
Part (a) Solution
a.
Group
Number
of
Headsets
1
50
2
3
×
Sales Price
per
Headsets
=
Total
Sales
Price
Relative
Sales
Price*
$10
$ 500
5/100
400
20
8,000
50
30
1,500
×
Total
Cost
Cost
Allocated
to
Headsets
Cost per
Headset"
$8,000
$ 400
$ 8
80/100
8,000
6,400
16
15/100
8,000
1,200
24
$10,000
=
$8,000
*5/500=$500/$10,000, 80/100=$8,000/$10,000; *15/100 = $1,500/$10,000
**$8 = $400/50; $16 = $6,400/400; $24 = $1,200/50
Copyright ©2022 John Wiley & Sons, Inc.
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Put It into Practice LO 8.3 Account for
Relative Sales Value and Purchase
Commitments
Part (b 1. and 2.) Solution
b. 1. If the commitment is material in amount, there should be a note disclosure sheet stating
the nature and extent of the commitment. The note may also disclose the market price of
the materials.
2. The drop in the market price of the commitment should be charged to operations in the
current year. The following entry would be made.
Loss on Purchase Commitments
3,600
Estimated Liability on Purchase
Commitments [12,000 × ($2.00 – $1.70)]
3,600
The entry is made because a loss in utility has occurred during the period in which the
market decline took place. The estimated liability account should be included among the
current liabilities on the balance sheet, with an appropriate footnote indicating the nature
and extent of the commitment. This liability indicates the minimum obligation on the
commitment contract at the present time—the amount that would have to be forfeited in
case of breach of contract.
Copyright ©2022 John Wiley & Sons, Inc.
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Put It into Practice LO 8.3 Account for
Relative Sales Value and Purchase
Commitments
Part (b 3.) Solution
3. Assuming the $3,600 market decline entry was made on December 31,2025, as indicated in
part (b2), the entry when the materials are received in January 2026 would be:
Raw Materials
20,400
Estimated Liability on Purchase Commitments
Accounts Payable
3,600
24,000
This entry records the raw materials at the actual cost ($1.70 per unit), eliminates the
$3,600 liability set up at December 31, 2025, and records the contractual liability for the
purchase (at $2.00 per unit). Cost of Goods Sold in 2026 is $20,400. The additional cost of
$3,600 is reported in income in 2025.
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Learning Objective 8.4
Determine ending inventory by applying the gross
profit method.
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Gross Profit Method of Estimating
Inventory
Substitute Measure to Approximate Inventory
1. Determine cost of goods available for sale by
adding beginning inventory to purchases.
2. Determine the cost of goods sold by subtracting
the estimated gross profit from sales revenue.
3. Determine ending inventory by subtracting cost of
goods sold from cost of goods available for sales.
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Gross Profit Method
Illustration: Lowery Stores has a beginning lumber inventory of $60,000 and
purchases of $200,000, both at cost. Sales at selling price amount to
$280,000. The gross profit on selling price is 30%. Lowery applies the gross
margin method as follows.
Beginning inventory (at cost)
$ 60,000
Purchases (at cost)
200,000
Cost of goods available for sale
260,000
Sales revenue (at selling price)
Less: Gross profit (30% of $280,000)
$280,000
84,000
Estimated cost of goods sold
Estimated ending inventory (at cost)
(196,000)
$
64,000
The current period’s records contain all the information Lowery needs to
compute inventory at cost, except for the gross profit percentage. Lowery
determines the gross profit percentage by reviewing company policies or
prior period records. In some cases, companies must adjust this percentage
if they consider prior periods unrepresentative of the current period.
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Gross Profit Method
Computation of Gross Profit Percentage
Illustration: In the previous illustration, the gross profit was a
given. But how did Lowery derive that figure? To see how to
compute a gross profit percentage, assume that an article cost
$15 and sells for $20, a gross profit of $5.
Markup $5

 25%at retail
Retail
$20
Markup $5

 33 1 % on cost
3
Cost
$15
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Gross Profit Method
Formulas
Percentage Markup on Cost
100% + Percentage Markup on Cost
1.
Gross Profit on Selling Price 
2.
Percentage Markup on Cost 
Gross Profit on Selling Price
100%  Gross Profit on Selling Price
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Gross Profit Formulas
Illustration: Tea Time has gross profit on selling price of 20% on
its Jasmine tea and 25% gross profit on selling price on its
Matcha green tea latte. Tea Time has a 25% markup on cost for
its Herbal tea and a 50% markup on cost on its Chai tea.
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Disadvantages of Gross Profit Method
Major Disadvantages
Result
Estimated value
Companies must take a physical inventory once a year to verify the inventory. The gross
profit test does not take into consideration the possibility that some goods have been
damaged or stolen.
Generally relies on past
percentages
Although the past often provides answers to the future, a current rate is more appropriate.
Note that whenever significant fluctuations occur, companies should adjust the percentage
as appropriate.
Varying gross profits require
caution
Frequently, a store or department handles merchandise with widely varying rates of gross
profit. In these situations, the company may need to apply the gross profit method by
subsections, lines of merchandise, or a similar basis that classifies merchandise according to
their respective rates of gross profit.
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Put It into Practice LO 8.4 Estimate
Inventory Using Gross Profit Method
Marling Corporation’s April 30 inventory was washed
away in a hurricane storm surge. The beginning
inventory on January 1 was $300,000, and purchases for
January through April totaled $700,000. Sales revenue
for the same period was $1,200,000. Marling’s normal
gross profit percentage is 40% on sales.
Instructions: Using the gross profit method, estimate
Marling’s April 30 inventory that was lost in the storm
surge.
Copyright ©2022 John Wiley & Sons, Inc.
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Put It into Practice LO 8.4 Estimate
Inventory Using Gross Profit Method
Solution
Beginning inventory
$300,000
Purchases
700,000
Cost of goods available for sale
1,000,000
Sales revenue
$1,200,000
Less: Gross profit (.40 × 1,200,000)
480,000
Estimated cost of goods sold
720,000
Estimated ending inventory destroyed in fire
$280,000
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Learning Objective 8.5
Determine ending inventory by applying the retail
inventory method.
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Advantages of Retail Inventory
Method
When to Use the Retail Inventory Method
Advantage
Interim reports
Provides a fairly quick and reliable measure of inventory.
To estimate losses
Is helpful to insurance adjusters who use this method to
estimate losses from fire, flood, or other type of casualty.
As a control device
Forces companies to explain any deviations from a physical
count at the end of the year.
To expedite the physical count
Saves time and expense because the crew taking the physical
inventory need record only the retail price of each item, not
each item’s invoice cost, thereby saving time and expense.
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Retail Inventory Method
Illustration: Kelvie Company’s beginning inventory has
a cost of $14,000 and a retail price of $20,000. The
company has also purchased inventory at a cost of
$63,000, which has a retail price of $90,000. Kelvie has
sales revenue for the period of $85,000.
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Retail Inventory Method
Computing Inventory
Illustration: This is how you would compute ending
inventory at both retail and cost using the retail
inventory method.
Cost
Retail
Beginning inventory
$14,000
$ 20,000
Purchases
63,000
90,000
Goods available for sale
$77,000
110,000
Less: Sales revenue
85,000
Ending inventory, at retail
$ 25,000
Cost-to-retail ratio ($77,000 ÷ $110,000) = 70%
Ending inventory at cost (.70 × $25,000) = $17,500
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Markup Cancellations, Markdowns,
and Markdown Cancellations
• Markup cancellations are decreases in prices of merchandise
that the retailer had marked up above the original retail
price.
• Markdowns are decreases in the original sales prices. Such
cuts in sales prices may be necessary because of a decrease
in the general level of prices, special sales, soiled or damaged
goods, overstocking, and market competition.
• Markdown cancellations occur when the markdowns are
later offset by increases in the prices of goods that the
retailer had marked down—such as after a one-day sale, for
example.
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Retail-Method Concepts
Illustration
Assume that Designer Clothing Store recently purchased
100 dress shirts from Marroway Inc. The cost for these
shirts was $1,500, or $15 a shirt. Designer Clothing
established the selling price on these shirts at $30 a shirt.
The shirts were selling quickly in anticipation of Father’s
Day, so the manager added a markup of $5 per shirt. This
markup made the price too high for customers, and sales
slowed. The manager then reduced the price to $32. Right
after Father’s Day, the manager marked down the
remaining shirts to a sale price of $23. The manager later
increases the price of the shirts to $24.
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Computing Markups
Retail-Method Concepts
The selling price of the shirts was
$30
The company had a markup of
5
The total price was reduced by $3, which is a markup cancellation
(3)
The company then reduced by price by $9 to $23, which results in a markup cancellation of $2 ($32 – $30) and a
markdown of $7
(9)
The company then increases the price by $1 to $24 (markdown cancellation)
1
The total price is then
$24
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Retail Inventory Method with
Markups and Markdowns—
Conventional and Cost Methods
Illustration: In-Fusion can calculate its ending inventory at cost under
two assumptions, A and B.
Assumption A: Computes a cost ratio after markups (and markup
cancellations) but before markdowns (and markdown cancellations).
This assumption is referred to as the conventional method.
Assumption B: Computes a cost ratio after both markups (and markup
cancellations) and markdowns (and markdown cancellations). This
assumption is referred to as the cost method.
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Retail Inventory Methods with Markups and
Markdowns
Cost
Retail
Beginning inventory
$ 500
$ 1,000
Purchases (net)
20,000
35,000
Markups
3,000
Markup cancellations
1,000
Markdowns
2,500
Markdown cancellations
2,000
Sales (net)
25,000
Beginning inventory
Cost
In-Fusion Inc.
$ 500
Retail
Purchases (net)
20,000
35,000
Merchandise available for sale
20,500
36,000
$ 1,000
Add: Markups
$3,000
Less: Markup cancellations
1,000
Net markups
(A)
_______
2,000
20,500
38,000
$ 20,500
Cost - to - retail ratio =
 53.9%
$38, 000
Less:
Markdowns
2,500
Markdown cancellations
(2,000)
Net markdowns
(B)
500
$20,500
$ 20,500
Cost - to - retail ratio =
 54.7%
$37,500
37,500
Less: Sales (net)
25,000
Ending inventory at retail
$12,500
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Value of Ending Inventory
The computations for In-Fusion are:
Assumption A: $12,500 × .539 = $6,737.50
Assumption B: $12,500 × .547 = $6,837.50
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Retail Inventory Method Including
Markdowns—Cost Method
Assume In-Fusion purchased two items for $5 apiece; the original sales price
was $10 each. One item was subsequently written down to $2. Assuming no
sales for the period, if markdowns are considered in the cost-to-retail ratio;
this is assumption B-the cost method, under which we compute the ending
inventory as shown below.
Purchases
Less: Markdowns
Cost
Retail
$10
$20
8
Ending inventory, at retail
$12
$10
 83.3%
$12
Ending inventory at cost ($12 ×.833) = $10
Cost - to - retail ratio =
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Retail Inventory Method Excluding
Markdowns—Conventional Method
Assume In-Fusion purchased two items for $5 apiece; the original sales price
was $10 each. One item was subsequently written down to $2. Assuming no
sales for the period, if markdowns are not considered in the cost-to-retail
ratio; this is assumption A-the conventional method, under which we
compute the ending inventory as shown below.
Purchases
Cost - to - retail ratio =
Cost
Retail
$10
$20
$10
 50%
$ 20
8
Less: Markdowns
Ending inventory, at retail
$12
Ending inventory at cost ($12 ×.50) = $6
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Conventional Retail Method
Illustration: Use the information for In-Fusion Inc.
The following is the ending inventory for In-Fusion using
the conventional method at the lower-of-cost-or-market.
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Conventional Retail Method
Ending Inventory Computation for In-Fusion,
Inc.
The following is the ending inventory for In-Fusion using
the conventional method at the lower-of-cost-or-market.
Cost - to -retail ratio=
=
Cost of goods available
Original retail priceof goods available, plus net markups
$20,500
= 53.9%
$38,000
Ending inventory at lower-of-cost-or-market (.539 × $12,500) = $6,737.50
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Special Items Relating to Retail Method
•
•
•
•
•
•
•
Freight costs
Purchase returns
Purchase discounts and allowances
Transfers-in
Normal shortages
Abnormal shortages
Employee discounts
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Conventional Retail Inventory Method
Special Items Included
Illustration: Extreme Sport Apparel as shown in
Illustration 9.12
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Evaluation of Retail Inventory Method
Used for the following reasons:
1. To permit the computation of net income without
a physical count of inventory.
2. Control measure in determining inventory
shortages.
3. Insurance information in case of a fire, flood, or
other casualty.
Some companies refine the retail method by
computing inventory separately by departments or
classes of merchandise with similar gross profits.
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Put It into Practice LO 8.5 Calculate
Ending Inventory Using the Retail
Method
Boylen Inc. had beginning inventory of $24,000 at cost
and $40,000 at retail. Net purchases were $240,000 at
cost and $350,000 at retail. Net markups were
$10,000, net markdowns were $7,000, and sales
revenue was $301,000.
Instructions: Compute ending inventory at cost using
the conventional retail method.
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Put It into Practice LO 8.5 Calculate
Ending Inventory Using the Retail
Method
Solution:
Cost
Retail
Beginning inventory
$ 24,000
$ 40,000
Net purchases
240,000
350,000
Net markups
_______
10,000
Totals
$264,000
400,000
Deduct:
Net markdowns
7,000
Sales revenue
301,000
Ending inventory at retail
$ 92,000
Cost-to-retail ratio: $264,000 ÷ $400,000 = 66%
Ending inventory at lower-of cost-or-market (66% × $92,000) = $60,720
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Learning Objective 8.6
Explain how to report and analyze inventory.
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Presentation and Analysis
Major Types of Disclosures
Financial reporting for inventories is extensive. Here are the major types of
disclosures provided:
• The basis on which a company states its inventory amounts (lower-of-cost-ornet realizable value or lower-of-cost-or-market).
• The method used in determining cost (specific identification, FIFO, averagecost, LIFO).
• The composition of inventory. For example, a manufacturer should report the
relative mix of raw materials, work in process, and finished goods.
• Significant or unusual financing arrangements relating to inventories.
Examples include transactions with related parties, product financing
arrangements, noncancelable purchase commitments, involuntary liquidation
of LIFO inventories, and pledging of inventories as collateral. Companies
should present inventories pledged as collateral for a loan in the current
assets section rather than as an offset to the liability.
Inventory standards require the consistent application of costing methods from one
period to the next.
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Pros and Cons of Inventory
Management
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Inventory Management—Ratios
Common ratios used in the management and
evaluation of inventory levels are inventory turnover
and average days to sell the inventory.
• Inventory turnover ratio – Measures the number of
times on average a company sells inventory during
the period.
• Average days to sell inventory – Measure
represents the average number of days’ sales for
which a company has inventory on hand.
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Learning Objective 8.7
Determine ending inventory by applying the LIFO
retail methods.
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Appendix 8A: LIFO Retail Methods
Primary reason to use LIFO
• Tax advantages
• Results in a better matching of costs and revenues
• Use of LIFO retail is made under two assumptions:
1.
2.
stable prices and
fluctuating prices.
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Stable Prices—LIFO Retail Methods
A major assumption of the LIFO retail method is that
the markups and markdowns apply only to the goods
purchased during the current period and not to the
beginning inventory.
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Stable Prices—LIFO Retail Methods
Illustration: Hernandez Company
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Stable Prices—LIFO Retail Methods
Ending Inventory at LIFO Cost 2025
Inventory is composed of two layers.
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Stable Prices—LIFO Retail Methods
Ending Inventory at LIFO Cost 2026
Notice that the 2025 layer is reduced from $11,000 to $5,000.
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Fluctuating Prices—Dollar-Value LIFO
Retail
If the price level does change, the company must
eliminate the price change so as to measure the real
increase in inventory, not the dollar increase.
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Fluctuating Prices—Dollar-Value LIFO
Retail
Illustration
Assume that the beginning inventory had a retail
market value of $10,000 and the ending inventory had
a retail market value of $15,000. Assume further that
the price level has risen from 100 to 125. It is
inappropriate to suggest that a real increase in
inventory of $5,000 has occurred. Instead, the
company must deflate the ending inventory at retail.
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Fluctuating Prices
Ending Inventory at Retail—Deflated and
Restated
Ending inventory at retail (deflated) $15,000 ÷ 1.25*
$12,000
Beginning inventory at retail
10,000
Real increase in inventory at retail
$ 2,000
Ending inventory at retail on LIFO basis:
First layer
$10,000
Second layer ($2,000 × 1.25)
2,500
$12,500
*1.25 = 125 ÷ 100
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Fluctuating Prices
Dollar-Value LIFO Retail Method—Fluctuating
Prices
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Ending Inventory at LIFO Cost
Illustration: From this information, we compute the
inventory amount at cost:
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Fluctuating Prices
Comparison of Effects of Price Assumptions
Illustration:
Difference between the LIFO approach (stable prices) and
the dollar-value LIFO method.
LIFO (stable prices)
Beginning inventory
Increment
Ending inventory
LIFO (fluctuating prices)
$27,000
$27,000
7,700
3,920
$34,700
$30,920
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Subsequent Adjustments Under DollarValue LIFO Retail
Increased Ending Inventory at LIFO Cost
Illustration: Using the data from the previous example, assume that the
retail value of the 2026 ending inventory at current prices is $64,800, the
2026 price index is 120% of base-year, and the cost-to-retail percentage is 75
percent. In base-year dollars, the ending inventory is $54,000 ($64,800 ÷
1.20).
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Subsequent Adjustments Under DollarValue LIFO Retail
Decreased Ending Inventory at LIFO Cost
Illustration: Using the data from the previous example, assume the ending
inventory in base-year prices is $48,000. When a real decrease in inventory
develops, Hernandez “peels off” previous layers at prices in existence when
the layers were added.
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Changing From Conventional Retail to
LIFO
Illustration: Hakeman Clothing Store employs the
conventional retail method but wishes to change to the
LIFO retail method beginning in 2026. The amounts shown
by the firm’s books are as follows.
Hakeman Clothing Store
At Cost
At Retail
Inventory, January 1, 2025
$ 5,210
$ 15,000
Net purchases in 2025
47,250
100,000
Net markups in 2025
7,000
Net markdowns in 2025
2,000
Sales revenue in 2025
95,000
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Conventional Retail Inventory Method
for Hakeman Clothing Store
Cost
Retail
Inventory January 1, 2025
$ 5,210
$ 15,000
Net purchases
47,250
100,000
_______
7,000
$52,460
122,000
Net additional markups
Net markdowns
(2,000)
Sales revenue
(95,000)
Ending inventory at retail
$ 25,000
Establishment of cost-to-retail percentage ($52,460 ÷ $122,000) =
43%
December 31,2025, inventory at cost
Inventory at retail
$ 25,000
Cost-to-retail ratio
×
Inventory at cost under conventional retail
.43
$ 10,750
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Conversion to LIFO Retail Inventory
Method
Hakeman Clothing can then quickly approximate the
ending inventory for 2025 under the LIFO retail
method.
December 31, 2025, Inventory at LIFO cost
Endinginventory 
Retail Ratio
LIFO


$25, 000 45% * $11,250
*The cost-to-retail ratio was computed as follows.
Net purchase at cost
$47,250

 45%
Net purchase at retail plus $100,000  $7,000  $2000
markups less markdowns
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Learning Objective 8.8
Compare the accounting procedures related to
valuation of inventories under GAAP and IFRS.
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IFRS Insights Relevant Facts
Similarities
• IFRS and GAAP account for inventory acquisitions
at historical cost and evaluate inventory for LCNRV
subsequent to acquisition.
• Who owns the goods—goods in transit, consigned
goods, special sales agreements—as well as the
costs to include in inventory are essentially
accounted for the same under IFRS and GAAP.
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IFRS Insights Relevant Facts
Differences
•
•
•
The requirements for accounting for and reporting inventories are more
principles-based under IFRS. That is, GAAP provides more detailed
guidelines in inventory accounting.
A major difference between IFRS and GAAP relates to the LIFO cost flow
assumption. GAAP permits the use of LIFO for inventory valuation. IFRS
prohibits its use. FIFO and average-cost are the only two acceptable cost
flow assumptions permitted under IFRS. Both sets of standards permit
specific identification where appropriate.
IFRS does not have an exception to the LCNRV rule for the LIFO/retail
inventory methods (IFRS does not allow LIFO). GAAP, on the other hand,
for LIFO/retail inventory method companies, defines market as
replacement cost subject to the constraints of net realizable value (the
ceiling) and net realizable value less a normal markup (the floor). IFRS
does not use a ceiling or a floor to determine lower-of-cost-or-market.
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IFRS Insight Relevant Facts
More Differences
•
•
Under GAAP, if inventory is written down under the LCNRV or
lower-of-cost-or-market valuation, the new basis is now
considered its cost. As a result, the inventory may not be written
back up to its original cost in a subsequent period. Under IFRS,
the write-down may be reversed in a subsequent period up to the
amount of the previous write-down. Both the write-down and
any subsequent reversal should be reported on the income
statement.
IFRS requires both biological assets and agricultural produce at
the point of harvest to be reported at net realizable value. GAAP
does not require companies to account for all biological assets in
the same way. Furthermore, these assets generally are not
reported at net realizable value. Disclosure requirements also
differ between the two sets of standards.
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Copyright
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may make back-up copies for his/her own use only and not for distribution or resale.
The Publisher assumes no responsibility for errors, omissions, or damages, caused by
the use of these programs or from the use of the information contained herein.
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