#### 9. Intermediate Accounting Chapter 9

cost-to-retail percentage

The retail inventory method uses the cost-to-retail percentage based on a current relationship between cost and selling price.

Dollarvalue LIFO retail method

Using the retail method to approximate LIFO is referred to as the dollar-value LIFO retail method.

Gross profit method

The gross pro?t method is not acceptable for the preparation of annual ?nancial statements.

net markup, net markdown

Net markups and net markdowns are included in the retail column to determine ending inventory at retail.

Net realizable value (NRV)

The ceiling ofnet realizable value (NRV) and the ?oor of net realizable value less a normal pro?t margin (NRV - NP) establish a range within which the market must fall.

Purchase commitments

Purchase commitments protect the buyer against price increases and provide a supply of product.

Replacement cost (RC)

Generally means the cost to replace the item by purchase or manufacture.

The method of recording inventory at market that substitutes the market value for cost and reports the loss as a part of cost of goods sold is the:

allowance method.

The primary basis of accounting for inventories is cost. A departure from the cost basis of pricing the inventory is required where there is evidence that when the goods are sold in the ordinary course of business their

future utility will be less than their cost.

In applying Lower-of-Cost-or-Market, the designated market value is

the middle value of replacement cost, net realizable value and net realizable value less a normal profit margin.

Net realizable value is defined as estimated selling price less purchase price.

FALSE

The direct method of recording inventory at market under the lower of cost or market rule establishes a separate contra asset account and a loss account to record the write-off.

FALSE

In applying the lower of cost or market rule, the floor is defined as:

net realizable value less a normal profit margin.

In the lower of cost or market rule, net realizable value is referred to as the:

ceiling

When the direct method is used adjust cost to "market", what account is debited?

Cost of Goods Sold.

Inventory may be recorded at net realizable value if

there are no significant costs of disposal, the inventory consists of precious metals or agricultural products, and there is a controlled market with a quoted price.

The LIFO retail method assumes that markups and markdowns apply to both beginning inventory and goods purchased during the period.

FALSE

The relative sales value method is used throughout the:

petroleum industry.

If a material amount of inventory has been ordered through a formal purchase contract at the balance sheet date for future delivery at firm prices,

this fact must be disclosed.

The percentage markup on cost can be computed by dividing gross profit by 100%:

minus gross profit.

The gross profit method of estimating inventory is acceptable for both interim and annual financial reports.

FALSE

Which of the following is included in the calculation of the cost-to-retail ratio under the conventional retail inventory method?

Markups and markup cancellations.

Which one of the following is deducted in computing the cost-to-retail ratio?

Abnormal shortages.

The conventional retail inventory method includes both net markups and net markdowns to calculate the cost-to-retail ratio.

FALSE

Lagasse Corporation's computation of cost of goods sold is:
Beginning Inventory $160,000 Add: Cost of goods purchased 605,000 Cost of goods available for sale 765,000 Ending inventory 180,000 Cost of goods sold$585,000
The average days to sell inventory

106.1 days.

Which of the following is not permitted under IFRS?

the use of the LIFO cost flow assumption.

The LIFO retail method assumes that markups and markdowns apply only to the goods purchased during the period.

TRUE

IFRS permits the use of the LIFO cost flow assumption and specific identification where appropriate.

FALSE

Colicchio Corporation acquired two inventory items at a lump-sum cost of $60,000. The acquisition included 3,000 units of knife X001, and 3,000 units of knife X002. X001 normally sells for$20 per unit, and X002 for $10 per unit. If Colicchio sells 1,000$3,330.

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, it is computed by dividing the inventory turnover by the number of days in the year (365 or sometimes for simplicity, 360).

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.

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.

cost-to-retail ratio

The total goods available for sale at cost divided by the total goods available for sale at retail price.

designated market value

The amount that a company compares to cost, when using the lower-of-cost-or-market (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.

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.

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.

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.

hedging

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.

inventory turnover

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.

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.

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.

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.

lower-of-cost-or-market (LCM)

Rule that dictates that a company value inventory at the lower-of-cost-or-market, 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.

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.

markdown

Decrease in the original sales prices.

markdown cancellations

Markdowns that are later offset by increases in the prices of goods that the retailer had marked down.

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.

markup

An additional markup of the original retail price.

markup cancellations

Decreases in the prices of merchandise that the retailer had marked up above the original retail price.

net realizable value (NRV)

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.

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.

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.

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.

upper limit (ceiling)

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.

Describe and apply the lower-of-cost-or-market rule.

If inventory declines in value below its original cost, for whatever reason, a company should write down the inventory to reflect this loss. The general rule is to abandon the historical cost principle when the future utility (revenue-producing ability) of the asset drops below its original cost.

Explain when companies value inventories at net realizable value.

Companies value inventory at net realizable value when (1) there is a controlled market with a quoted price applicable to all quantities, (2) no significant costs of disposal are involved, and (3) the cost figures are too difficult to obtain.

Explain when companies use the relative sales value method to value inventories.

When a company purchases a group of varying units at a single lump-sum price�a so-called basket purchase�the company may allocate the total purchase price to the individual items on the basis of relative sales value.

Discuss accounting issues related to purchase commitments.

Accounting for purchase commitments is controversial. Some argue that companies should report purchase commitment contracts as assets and liabilities at the time the contract is signed. Others believe that recognition at the delivery date is most appropriate. The FASB neither excludes nor recommends the recording of assets and liabilities for purchase commitments. However, companies record losses when market prices fall relative to the commitment price.

Determine ending inventory by applying the gross profit method.

Companies follow these steps to determine ending inventory by the gross profit method. (1) Compute the gross profit percentage on selling price. (2) Compute gross profit by multiplying net sales by the gross profit percentage. (3) Compute cost of goods sold by subtracting gross profit from net sales. (4) Compute ending inventory by subtracting cost of goods sold from total goods available for sale.

Determine ending inventory by applying the retail inventory method.

Companies follow these steps to determine ending inventory by the conventional retail method. (1) To estimate inventory at retail, deduct the sales for the period from the retail value of the goods available for sale. (2) To find the cost-to-retail ratio for all goods passing through a department or firm, divide the total goods available for sale at cost by the total goods available at retail. (3) Convert the inventory valued at retail to approximate cost by applying the cost-to-retail ratio.

Explain how to report and analyze inventory.

Accounting standards require financial statement disclosure of (1) the composition of the inventory (in the balance sheet or a separate schedule in the notes), (2) significant or unusual inventory financing arrangements, and (3) inventory costing methods employed (which may differ for different elements of inventory). Accounting standards also require the consistent application of costing methods from one period to another. Common ratios used in the management and evaluation of inventory levels are inventory turnover and average days to sell inventory.