Glossary—Chapter 9
average days to sell inventory A measure that represents the average number of days’ sales for which
inventory is on hand. A variant of the inventory turnover ratio, it is computed by dividing the inventory
turnover ratio by the number of days in the year (365 or sometimes for simplicity, 360). (p. 516).
conventional retail inventory method A method of valuing ending inventory that uses only a cost ratio
using markups but not markdowns, thereby approximating the lower-of-average-cost-or-market. (p. 510.)
cost-of-goods-sold method A method of valuing inventory in which cost of goods sold is debited for the
write-down of inventory to market. As a result, the company does not report a loss in the income statement
because the cost of goods sold already includes the amount of loss. (p. 498).
cost-to-retail ratio The total goods available for sale at cost divided by the total goods available for sale at
retail price. (p. 509).
designated market value The amount that a company compares to cost, when using the lower-of-cost-ormarket (LCM) rule. The designated market value is the middle value of three amounts: replacement cost,
net realizable value, and net realizable value less a normal profit margin. (p. 496).
gross profit method Method of determining inventory amount, often used when it is impossible or
impractical to take a physical inventory. In this method, companies compute the gross profit percentage on
selling price, multiply that percentage times net sales to determine gross profit, subtract gross profit from
net sales to find cost of goods sold, and subtract cost of goods sold from total goods available for sale to
determine ending inventory. Also called the gross margin method. (p. 505).
gross profit percentage Measure used in the gross profit method; it represents the rate (percentage) of
profit a company expects from some convenient measure, usually sales. This rate is determined by
company policy and prior-period experience. (p. 506).
hedging (purchase commitments) The purchaser in the purchase commitment simultaneously enters into
a contract in which it agrees to sell in the future the same quantity of the same (or similar) goods at a fixed
price. The company holds a buy position in a purchase commitment and a sell position in a futures contract
in the same commodity. (p. 504).
inventory turnover ratio Liquidity ratio that measures the number of times on average a company sells its
inventory during the period. Computed as the cost of goods sold divided by the average inventory on hand
during the period. Analysts compute average inventory from beginning and ending inventory balances. (p.
516).
loss method A method of valuing inventory in which a loss account is debited for the write-down of the
inventory to market, as opposed to the cost-of-goods-sold method, which buries the loss in the Cost of
Goods Sold account. (p. 498).
lower limit (floor) In the lower-of-cost-or-market (LCM) rule, the lowest amount at which inventory can
be reported; computed as the net realizable value less a normal profit margin. This minimum amount
measures what the company can receive for the inventory and still earn a normal profit. (p. 495).
lower-of-cost-or-market (LCM) Rule that dictates that a company value 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. Thus, companies abandon the historical cost principle when
the revenue-producing ability of an asset drops below its original cost. (p. 495).
lump-sum (basket) purchase The single purchase of a group of varying units. To determine the cost for
the individual assets acquired in a lump-sum purchase, the company allocates the total cost among the
various assets on the basis of their relative fair values. (p. 502).
markdown Decrease in the original sales prices. (p. 509).
markdown cancellations Markdowns that are later offset by increases in the prices of goods that the
retailer had marked down. (p. 510).
market (for LCM) The cost to replace an inventory item by purchase or reproduction. For a retailer,
“market” refers to the market in which a company purchases goods, not the market in which it sells them.
For a manufacturer, the term “market” refers to the cost to reproduce. Thus, lower-of-cost-or-market means
that companies value goods at cost or cost to replace, whichever is lower. (p. 494).
markup An additional markup of the original retail price. (p. 509).
markup cancellations Decreases in the prices of merchandise that the retailer had marked up above the
original retail price. (p. 509).
net realizable value (NRV) (inventories) In the lower-of-cost-or-market approach, the estimated selling
price in the ordinary course of business, less reasonably predictable costs of completion and disposal. The
NRV represents the ceiling (upper limit) under LCM. (p. 495).
net realizable value less a normal profit margin In the lower-of-cost-or-market approach, the floor
(lower limit), calculated as the NRV minus a normal profit margin. (p. 495).
purchase commitments Agreements to buy inventory weeks, months, or years in advance. The seller
generally retains title to the merchandise or materials covered in the purchase commitments. (p. 503).
retail inventory method A method of valuing inventories that requires that a retailer keep a detailed record
of (1) the total cost and retail value of goods purchased, (2) the total cost and retail value of the goods
available for sale, and (3) the sales for the period. (p. 508).
upper limit (ceiling) In the lower-of-cost-or-market (LCM) approach, the highest amount at which
inventory can be reported, which is the inventory’s net realizable value. The ceiling prevents overstatement
of inventories and understatement of the loss in the current period. (p. 495).
Appendix 9A:
dollar-value LIFO retail method A method of valuing ending inventory that assumes a change in the
price level of inventories, which the company must eliminate so as to measure the real increase in
inventory, not the dollar increase. (p. 519).
LIFO retail method A method of valuing ending inventory that assumes that the markups and markdowns
apply only to the goods purchased during the current period and not to the beginning inventory. (p. 518).