384
Part Two Assets
Retail Inventory Hmm0vwm\'r"\
[inmi»n>\—i*mma\mLm
Method particularly department stores, to arrive a
asition whenever desired. This method, I
rmits the calculation of an inventory amount without the time ar
expense of taking a physical inventory or maintaining a detailed perpetual
inventory record for each of the thousands of items normally included in a
retail inventory. When this method is used, records of goods purchased are
maintained at two amounts—cost and retail. The computet has now made
it feasible to maintain cost records for the thousands of items normally
included in a retail inventory. A cost percentage is computed by dividing
the goods available for sale at cost by the goods available for sale at rerail.
This cosr percenrage can then be applied to the ending inventory at retail,
amount that can be readily calculated by subtracring sales for the period
he total goods available for sale at retail.
The computation of retail inventory at the end of a month is illustrated
by the following example:
Cost
Retail
Inventoty. Januaty 1
$30,000 $45,000
Purchases in January
20,000
35.000
Goods available for sale
$50,000 $80,000
Cost percentage ($50,000 - $80,000) = 62 5%
Deduct sales lor January
25,000
Inventory. January 31. at retail
$55,000
Inventory. January 31. at estimated cost
($55,000 x 62 5%)
$34 375
The effect ot die above procedure is to provide an inventory valuation in
rms of average cn*» yj^^tKfcxtf^BkftjbB^Njich as LIFO or FIFQaMiig^m^d^^
i the preceding computation; the percentage of cost to retail for the ending
ventory is rhe same as the percentage of cost to retail for goods sold.
Use of the retail inventory method offers the following advantages:
1. Estimated intetim inventories can be obtained without a physical
count.
2. When a physical inventory is actually taken for financial statement purposes, it can be taken at retail and then converted to cost without reference to individual costs and invoices, thus saving time and expense.
3. Shoplifting losses can be determined and monitored. Since physical
counts of inventory costed at retail should agree with the calculated
retail inventory, any difference not accounted for by clerical errors in
the company records must be attributable to actual physical loss by
shoplifting ot employee theft.
Although this method permits the estimation of a value fot inventory,
errors can occur in accounting for the dual prices and in applying the retail
method. Thus, a physical count of the inventory to be reported on the
annual financial statements is required at least once a year. Retail invenSố hóa bởi Trung tâm Học liệu – ĐH TN
http://www.lrc-tnu.edu.vn
385
Chapter 10 Inventories—Estimation and Noncost Valuation Procedures
tory records should be adjusted for variations shown by the physical count
so that records reflect the actual status of the inventory for purposes of
future estimates and control.
The accounting entries for the retail inventory method are similar
those made using a periodic inventory system. The retail figures are part of
the analysis necessary to compute the cost of the inventory; howevet, they
do not actually appear in the accounts. Thus, the following entries would
be made to record the inventory data included in the preceding example.
Purchases JO,000
Accounts Payable
Accounts Receivable
Sales
Inventory
Cost of Goods Sold
Purchases
To adjust inventory, cost of goods sold, and
related accounts.
25,000
4,375
15,625
20,000
25,000
20,000
Markups and • In the earlier inventory calculations, it was assumed that there were no
Markdowns— changes in retail prices after the goods were originally recorded.
Conventional Retail Frequently, however, retail prices do change because of changes in the
price level, shifts in consumer demand, or other factors. The following
terms are used in discussing the retail method:
1. Original retail—the initial sales ptice, including the original inctease
over cost refened to as the initial markup.
2. Additional markups—increases that raise sales prices above original re3. Markup cancellations—decreases in additional markups that do not reduce sales prices below original retail.
4. Net markups—Additional markups less markup cancellations.
5. Markdowns—decreases that reduce sales prices below original retail.
6. Markdown cancellations—decreases in the markdowns that do not raise
the sales prices above original retail.
7. Net markdowns—markdowns less markdown cancellations.
To illustrate the use of these terms, assume that goods originally placed
for sale are marked at 50% above cost. Merchandise costing $4 a unit,
then, is matked at $6, which is the original retail. The initial markup of $2
is referred to as a "50% markup on cost" or a "3314% markup on sales
price." In anticipation of a heavy demand for the article, the retail price is
subsequently increased to $7.50. This represents an additional markup of
$1.50. At a latet date the price is reduced to $7. This is a markup cancellation of 50 cents and not a markdown since the retail price has not been
reduced below the original sales price. But assume that goods originally
Số hóa bởi Trung tâm Học liệu – ĐH TN
http://www.lrc-tnu.edu.vn
386
Part Two Assets
marked to sell at $6 are subsequently reduced to a sales price of $5. This
represents a markdownofjl- At a later date the goods are marked to sell at
$5.25. This is a markdown cancellation of 25 centsjind not a markup, since
sales price does not exceed the original retail.
Retail inventory results will vary depending on whether net markdowns
are used in computing the cost percentage. When applying I
monly used retail method, net markups are added to goods available
at^retail before calculating the cost percentage; net markdowns,
are not deducted in arriving at the percentage. This method, sor
>
'
•
--r'
rioiMMiiatoetoMMr'""'"'
following example:
1
:
!
Net markdowns not deducted to calculate cost percentage (Conventional
retail):
Beginning inventory
Purchases
Additional markops
Markup cancellations
Goods available for sale
Cost percentage ($80,700 4- $134,500) = 60%
Deduct Sales
Markdowns
Markdown cancellations
Cost
Retail
$ 8,600
72,100
$ 14.000
110.000
13.000
(2.500)
$ 134 500
$80,700
$ 108 000
4.800
(800)
$ 112.000
Ending inventory at retail
$ 22 500
inventory atretail
estimated
cost ($22,500
x 60%)
TheEnding
conventional
method
results in
a lower$13.500
cost percentage and,
correspondingly, a lower inventory amount and a higher cost of goods sold
than would be obtained if net markdowns were deducted before calculating
:pr the cost percentage. This lattet approach, the average cost retail inventory
method, is illustrated at the top of page 387.
The lower inventory obtained with the conventional retail methodapproximates a lower of average cost or market valuation. The lower of cost
or market concept, discussed in detail later in this chapter, requires recognition of declines in the value of inventory in the period such declines
occur. Under the conventional retail method, markdowns are viewed as
indicating a decline in the value of inventory and are deducted as a current
cost of sales. When markdowns are included in the cost percentage computation, the tesult is an average cost allocated proportionately between cost
of sales and ending inventory. Thus, only a portion of the decline in value
is charged in the current period. The remainder is carried forward in ending inventory to be charged against future sales.
Số hóa bởi Trung tâm Học liệu – ĐH TN
http://www.lrc-tnu.edu.vn
Chapter 10 Inventories—Estimation and Noncost Valuation Procedures
387
Net markdowns deducted to calculate cost percentage (average cost retail):
Cost Retail
Goods available for sale (conventional retail)
$80,700 $134,500
Deduct net markdowns
" 4,000
Goods available for sale (average cost retail)
$130,500
Cost percentage ($80,700 + $130,500) = 61.84%
Deduct sales
108,000
Ending inventory at retail
$ 22,500
Ending inventory at estimated cost ($22,500 x 61.84%)
$13,914
Matkdowns may be made for special sales or clearance purposes, or they
may be made as a result of market fluctuations and a decline in the replacement cost of goods. In either case their omission in calculating the cost
percentage is necessary in order to value the inventory at the lower of cost
or market. This is illustrated in the two examples that follow:
Example 1 Markdowns for special sales purposes
Assume that merchandise costing $50,000 is marked to sell for
$100,000. To dispose of part of the goods immediately, one fourth of the
stock is marked down $5,000 and is sold. The cost of the ending inventory
is calculated as follows:
Purchases
Cost percentage ($50,000 + $100,000) = 50%
Deduct Sales
Markdowns
Cost Retail
$50,000 $100,000
$ 20,000
5,000
$ 25,000
Ending inventory at retail
% 75.000
Ending inventory at estimated cost ($75,000 x 50%)
$37,500
If cost, $50,000, had been related to sales price after markdowns,
$95,000, a cost percentage of 52.6% would have been obtained, and the
inventory, which is three fourths of me merchandise originally acquired,
would have been reported at 52.6% of $75,000, or $39,450. The inventory
would thus be stated above the $37,500 cost of die^remaining inventory
and cost of goods sold would be understated by $1,950. A markdown relating to goods no longer on hand would have been recognized in the development of a cost percentage to be applied to the entire inventory.
Reductions in the goods available at sales prices resulting from shortages or
damaged goods should likewise be disregarded in calculating the cost percentage.
x
Example 2 Markdowns as a result ot market declines
Assume that merchandise costing $50,000 is marked to sell for
$100,000. With a drop in replacement cost of merchandise to $40,000,
Số hóa bởi Trung tâm Học liệu – ĐH TN
http://www.lrc-tnu.edu.vn
388
Part Two Assets
sales prices are marked down to $80,000. Three fourths of the merchandise
is sold. The cost of the ending inventory is calculated as follows:
Cost
Retail
$50,000 $100.000
Purchases
Cost percentage ($50,000 * $100,000) = 50%
Deduct: Sales
Markdowns
$ 60.000
20,000
$ 80,000
$ 20,000
Ending inventory at retail
Ending inventory at estimated cost ($20,000 x 50%)
$10.000
If cost, $50,000, had been related to sales price after markdowns,
$80,000, a cost percentage of 62.5% would have been obtained and the
inventory would have been reported at 62.5% of $20,000, ot $12,500. The
use of the 50% cost percentage in the example teduces the inventory to
$10,000, a balance providing the usual gross profit in subsequent periods if
current prices and relationships between cost and retail prices prevail.
Freight, Discounts, In calculating the cost percentage, freight in should be added to rhe exist ol
AMowa'nces
P
i purchase discounrs and returns and allowances should be
deducted. A purchase return affects both the cost and the retail
computations, while a purchase allowance affects only the cost total unless a
change in retail price is made as a result of the allowance. Sales returns are
proper adjustments to gross sales since the inventors is returned; however,
sales discounts and sales allowances are not deducted to determine the
estimated ending retail inventory. The deduction is not made because the
sales price of an item is added into the computation of the retail inventory
when it is purchased and deducted when it is sold, all at the gross sales price.
Subsequent price adjustments included in the computation would leave a
balance in the inventory account with no inventory on hand to represent it.
For example, assume the sales price for 100 units of Product A is $5,000.
When these units are sold for $5,000, the retail inventory balance would be
zero. Subsequently, if an allowance of $100 is granted to the customer, the
allowance would not be included in the computation of the month-end retail
inventory balance. It would be recorded on the books, however, in the usual
manner debit Sales Allowances and credit Accounts Receivable.
R
c n e
u r c n a s e
-
Retail Method with
Varying Pram Margin
The calculation of a cost percentage for all goods carried in inventory is
\[(\ \y
e n goods on hand can be regarded as representative of the
total goods handled. Varying markup percentages and sales of high-margin
and low-margin items in proportions that differ from purchases will require
separate records and the development of separate cost percentages for
different classes of goods. For example, assume that a store operates three
departments and that for July the following information pertains to these
departments:
va
on
w n
Số hóa bởi Trung tâm Học liệu – ĐH TN
http://www.lrc-tnu.edu.vn
Chapter 10 Inventories—Estimation and Noncost Valuation Procedures
389
Departmant B
Departmant C
Popartmont A
Total
Cost Retail
Cost Relail
Cott Retail
Cost
Retail
Beginning inventory $20,000 $ 28,000 $10,000 $15,000 $16,000 40,000 $ 46,000 $ 83,000
Net purchases
57,000 82,000 20,000 35,000 20,000 60,000
97,000 177,000
Goods available for $77,000
$260,000
$110,000$30,000
$50,000 $36,000 $100,000 $143,000
sale
70%
60%
5
5
%
36%
Cost percentage
150,000
80,000
30,000
40,000
Sales
$110,000
$ 30,000
$20,000
I 60,000
Inventory at retail
$ 60.500
$ 21,000
$12,000
; 21,600
Inventory at cost
$54,600
Because of the range in cost percentages from 36% to 70% and the difference in mix of the purchases and ending inventory, the ending inventory
balance, using an overall cost percentage, is $5,900 higher ($60,500 $54,600) than when the departmental rates are used. When material variations exist in the cost percentages by depattments, separate departmental
rates should be computed and applied.
The retail method is acceptable for income tax purposes, provided the
taxpayer maintains adequate and satisfactory records supporting inventory
calculations and applies the method consistently on successive tax returns.
Dollar-Value The dollar-value LIFO procedures described in Chapter 9 can be applied to
LIFO Retail the retail inventory method in developing inventory values reflecting a
Method [ , j flrst-outvaluation approach. The dollar-value LIFO retail method
requires that index numbers be applied to inventories stated at retail in
arriving at the quantitative changes in inventories. After the LIFO retail
layers have been identified and priced at the incremental layer index, a
further adjustment is needed to state the inventory at cost. This is done by
multiplying the retail inventory of each layer by the incremental cost
percentage.
The incremental cost percentages for the dollar-value LIFO retail
method are computed in a slightly different manner from that done fot the
conventional retail method. The two principal differences are:
1
asr
ni
1. Beginning inventory values are disregarded. The LIFO inventory is
composed of a base cost and subsequent cost layers that have not been
assigned to revenues. Because costs for prior periods remain unchanged,
only the cost of a current incremental layer requires calculation.
2. Markdowns, as well as markups, are recognized in calculating the cost
percentage applicable to goods stated at retail. Markdowns were not
recognized in arriving at the cost percentage when the objective was to
R
' eeve and Stanga found that 195 relail companies in the U S used LIFO, and thai over 95% of those used
Ihe dolar-value LIFO retail method James M Reeve and Keith G Stanga, "The LIFO Pooling Decision
Some Empirical Results from Accounling Practice," Accounling Horizons (June 1987), p 27
Số hóa bởi Trung tâm Học liệu – ĐH TN
http://www.lrc-tnu.edu.vn
390
Part Two Assets
^gpj^m&mmtmmtm
uim\iu mluum u llui i nl cause umm
•jjpeasurements require invento^uiialBttfiWBatiHas of cost, the recog^jaj)
ajjjJif^afyBtilBrinarkups and markdowns is appropriate**
Even though the beginning inventories are not included in the computation of the cost percentage, they are used to determine the amount of retail
inventory that should be on hand at the end of the petiod. Because the
retail inventory is adjusted for markups and markdowns, the ending inventory is automatically stated at year-end retail prices.
To illustrate the computation of the LIFO retail incremental cost percentage, the ending inventory at year-end retail prices, and the inventory
at dollar-value LIFO retail, assume that the following LIFO retail layer data
apply to Morris Department Stores Inc. as of December 31, 1991.
Year-End and
Incremental Price
Indea
1.00
1 05
1.10
1.12
Incremental
Coat
Percentage
60
62
64
65
Inventory
at End-OfYear Retail
Prlcea
$60,000
69.300
77.000
77,280
Layer Year
1987
1988 (no layer)
1989
1990
1991
Assume that the 1992 year-end price index is 1.08. The incremental cost
percentage and 1992 ending inventory at end-of-year retail pnces ate computed as follows:
Coat
Beginning inventory—December 31, 1991
Purchases
Purchase returns
Purchase discounts
Freight in
Markups, net of cancellations
Markdowns, net of cancellations
Totals to determine incremental
cost percentage—retail-LIFO
Incremental cost percentage \
~" (36Z220~^$7T^
Goods available for"iale^~Deduct: Sales
Ending inventory at retail (year-end prices)
Retail
$ 77,280
$ 63,000 $ 9W0U
(2,000)
(3,000)
(1,000)
2,220
8,000
(i.QQQ)
$ 62,220 $ 102,000
$ 179,280
100,960
$ 78,300}
~~~7'
From these data, a worksheet similar to that illustrated in Chapter 9 for
dollar-value LIFO can be constructed to determine the LIFO retail inventory layers. One additional column is necessary to record the incremental
cost percentage that will reduce the retail inventory to cost. It is important
to note that the incremental cost percentage is used only if an incremental
Số hóa bở
i Trung
tâm to
Họthe
c liệinventory
u – ĐH TN
http://www.lrc-tnu.edu.vn
layer
is added
in the current
period. In the example, this
situation occurred in 1991 when no layer was added. If the inventory level
391
Chapter 10 Inventories—Estimation and Noncost Valuation Procedures
has declined, previous inventory levels will be reduced using the respective
years' incremental layer index and incremental cost percentage.
Dollar-Value LIFO Retail
Inventory
at End-ofYear
Retail
$60,
000 -Prices
$69,300 --
Inventory
Year- •t BateIncremental
End
Increment:
Year
Cod
Date
Layer* LayerIndeil
Price
Retail
• X Percentage
December 31,
X
Index
1.00 •= $60,
0
00
$60,
0
00
1
.
0
0
60
Prices
1988
December 31,
1.05 == $66,000 $60,000 X
1.00 • x
60
1989
6,000 X
1.05
X
62
$66,000
December 31,
$77,000 -- 1.10 == $70,000 $60,000 X
1.00
X
.60
1990
6,000 x
1.05
x
62
4,000 X 1.10
X
64
$70,000
December 31,
$77,280 -- 1.12 == $69,000 $60,000 X 1.00
X
60
1991
6.000 X
1 05 X
62
3.000 X
1.10
X
64
$69,000
December 31,
$78,300 -- 1.08 == $72,500 $60,000 X
1,00
X
.60
1992
f
6,000 X
1.05
X
62
3.000 X 1 10 X
.64
-•
3.500 X 1 08 X
.61
$72,500
r'ounded to nearest dollar
=
=
=
=
=
DollarValue
LIFO
Retail
$36,
000
Cost
$36,000
3,906
$39,906
$36,000
3,906
2,816
$42,722
$36,000
3,906
2,112
$42,018
$36,000
3,906
2,112
2,306'
$44,324
Inventory The basic cost procedures for determining inventory values have been
Valuations at discussed in this and the previous chapter. In some cases, generally
Other Than Cost accepted accounting principles permit deviations from cost, especially if a
write-down of inventory values is warranted. The following sections of this
chapter discuss some of these departures from historical cost and the
circumstances under which they are appropriate.
Inventory Valuation The conceptual framework establishes and defines recognition criteria for
at Lower of Cost or the elements of the financial statements. The definition of an asset tequires
Market that it produce future benefits to the owner If at any time the monetary
value assigned to an asset overstates these futute benefits, an adjustment
should be made to reflect a loss. Recognition criteria limit the adjustment
to situations where the asset value can be estimated and a probable loss
exists. The application of these accounting concepts to inventory is known
as valuation at the lower of cost or market (LCM).
Currently, generally accepted accounting ptinciples permit tecognition
of increases in the value of assets above cost only atter the increase is re;
ized and/or earned. The current ptactice of recognizing inventory write
downs before realization but not inventory writeups until after realization
results in inconsistent tteatment of value changes.
Số hóa bởi Trung tâm Học liệu – ĐH TN
http://www.lrc-tnu.edu.vn
392
Part Two Assets
The American Institute of Certified Public Accountants (AICPA)
sanctioned lower of cost or market valuation in the following statement:
A departure from the cost basis of pricing the inventory is required when the
utility of the goods is no longer as great as its cost. Where there is evidence
that the utility of goods, in their disposal in the ordinary course of business,
will be less than cost, whether due to physical deterioration, obsolescence,
changes in price levels, or other causes, the difference should be recognized as
a loss of the current period. This is generally accomplished by stating such
goods at a lower level commonly designated as market.In applying the lower of cost or market rule, the cost of the ending
inventory, as determined under an appropriate cost allocation method, is
compared with market value at the end of the period. It marker is less than
cost, an adjusting entry is made to record the loss and restate ending inventory at the lower value. It should be noted that no adjustment to LIFO cost
is permitted for tax purposes; however, for financial reporting purposes, rhe
lower of cosr or market rule applies to all inventories. Application of LCM
to LIFO inventories tor financial reporting purposes does not violate the
"LIFO conformity" rules it IRS approval is obtained.
Definition of Market
The term marker in "lower of cost or market" is interpreted as replacement
cost with upper and lower limits that reflect estimated realizable values.
This concept of market was stated by the AICPA as follows:
As used in the phrase (ou'er of cost or market, the term marker means current
replacement cost (by purchase or bv reproduction, as the case mav be) except
that:
(1) Market should not exceed the net realizable value (i.e., estimated selling price in the ordinary course of business less reasonably predictable
costs of completion and disposal); and
(2) Market should not be less than net tealizable value reduced by an allowance for an approximately normal profit margin.
Replacement cost, sometimes referred to as entry cost, includes the purchase price of the product or raw materials plus all other costs incurred in
the acquisition or manufacture of goods. Because wholesale and retail
prices are generally related, declines in entry costs usually indicate declines
in selling prices or exit values. However, exit values do not always respond
immediately and in proportion to changes in entry costs. If selling price
does not decline, thete is no loss in utility and a write-down of inventory
values would not be warranted. On the other hand, selling prices may decline in response to factors unrelated to replacement costs. Perhaps an inventoty item has been used as a demonstrator which reduces its
5
'Accounting Research and Terminology Bulletins^Fmal Edition. No 43. ' Restatement and
counting Research Bulletins'' (New York American Institute of Certified Public Accountants. 1961). Ch 4.
statement
5
ltvd . statement
6
Số hóa bởi Trung tâm Học liệu – ĐH TN
http://www.lrc-tnu.edu.vn
3
Chapter 10 Inventories—Estimation and Noncost Valuation Procedures
393
marketability as a new product. Or perhaps an item is damaged in storage
or becomes shopworn from excessive handling.
The AICPA definition considers exit values as well as entry costs by
establishing a ceiling for the market value at sales price less costs of completion and disposal and a floor for market at sales price less both the costs
of completion and disposal and the normal profit marginrfhe ceiling lima*
tation is applied so the inventory is not valued at more than its net realizable value (NRV). Failure to observe this limitation would result in charges
to future revenue that exceed the utility earned forward and an ultimate
loss on the sale of the inventory. The floor limitation is applied so the
inventory is not valued at less than its net realizable value minus a normal
profit. The concept of normal profit is a difficult one to measure objectively. Profits vary by item and over time. Records are seldom accurate
enough to determine a normal profit by individual inventory item. Despite
these difficulties, however, the use of a floor prevents a definition of market that would result in a write-down of inventory values in one period to
create an abnormally high profit in future periods.
Applying Lower of Cost or Market Method
Application of the LCM rule to determine the appropriate inventory valuation may he summarized in the following steps:
1. Define pertinent values: cost, replacement cost, upper limit (NRV),
lower limit (NRV — normal profit).
2. Determine "market" (replacement cost as modified by upper or lower
limits).
3. Compare cost with market (as defined in 2 above), and select the lower
amount.
To illustrate these steps, assume that a certain commodity sells for_Jl:._
selling expenses are $.20; the notmal profit is 25% of sales or $.25. The
lower of cost or market as modified by the uppet and lower limits is developed in each case as shown in the illustration below.
Market
Upper LimitLower Limit—Floor
^Market.
Celling
(Estimated
tales
price
(Limited
by Lower ol
Replacement
(Estimated
sales
Cost or
Case Coil
Hess selling expenses
floor and
Cost
price less selling
and
normal
profits)
ceiling
A $.65
$ 70
$55
$70values) Market
$.80
$65
expenses)
B
.65
.60
.55
80
.60
.60
C
.65
50
55
80
55
55
D
.50
.45
55
80
.55
.50
E
75
.85
.55
80
80
75
F
90
1.00
.55
80
80
80
A: Market is not limited by floor or ceiling; cost is less than market
B: Market is not limited by floor or ceiling; market is less than cost
C: Market is limited to floor; market is less than cost.
D Market is limited to floor, cost is less than market
E MarketSố
is hó
limited
toiceiling;
t is less
nm
a bở
Trungcostâm
Họcthaliệ
ua–rketĐH TN
http://www.lrc-tnu.edu.vn
F Market is limited to ceiling, market is less than cost