Intermediate Accounting Seventeenth Edition Kieso ● Weygandt ● Warfield Chapter Inventories: Additional Valuation Issues This slide deck contains animations Please disable animations if they cause issues with your device Learning Objectives After studying this chapter, you should be able to: Describe and apply the lower-of-cost-or-net realizable value rule Describe and apply the lower-of-cost-or-market rule Identify other inventory valuation issues Determine ending inventory by applying the gross profit method Determine ending inventory by applying the retail inventory method Explain how to report and analyze inventory Copyright ©2019 John Wiley & Sons, Inc Preview of Chapter Inventories: Additional Valuation Issues Lower-of-Cost-or-Net Realizable Value • Definition • Illustration • Methods of applying • Recording Use of allowance Multiple periods Copyright â2019 John Wiley & Sons, Inc Preview of Chapter Lower-of-Cost-or-Market • How LCM works • Methods • Evaluation of LCNRV and LCM rules Other Valuation Approaches • Net realizable value Relative sales value Purchase commitments Copyright â2019 John Wiley & Sons, Inc Preview of Chapter Gross Profit Method • Gross profit percentage • Evaluation of method Retail Inventory Method • Concepts • Conventional method • Special items Evaluation of method Copyright â2019 John Wiley & Sons, Inc Preview of Chapter Presentation and Analysis Presentation Analysis Copyright â2019 John Wiley & Sons, Inc Learning Objective Describe and Apply the Lower-of-Costor-Net Realizable Value Rule LO Copyright ©2019 John Wiley & Sons, Inc 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 LO Copyright ©2019 John Wiley & Sons, Inc Definition of Net Realizable Value Illustration Assume that Mander Corp 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 Mander’s net realizable value is computed as follows LO Copyright ©2019 John Wiley & Sons, Inc Definition of Net Realizable Value LCNRV Disclosures • Mander reports inventory at $750 • In its income statement, Mander reports a Loss Due to Decline of Inventory to N R V of $200 ($950 − $750) Kesa Electricals Inventories are stated at the lower-of-cost-or-net realizable value Cost is determined using the weighted average method Net realisable value represents the estimated selling price in the ordinary course of business, less applicable variable selling expenses LO Copyright ©2019 John Wiley & Sons, Inc 10 Fluctuating Prices Ending Inventory at Retail—Deflated and Restated LO Copyright ©2019 John Wiley & Sons, Inc 72 Fluctuating Prices Dollar-Value LIFO Retail Method—Fluctuating Prices LO Copyright ©2019 John Wiley & Sons, Inc 73 Fluctuating Prices Dollar-Value LIFO Retail Method—Fluctuating Prices Illustration: From this information, we compute the inventory amount at cost: Hernandez must restate layers of a particular year to the prices in effect in the year when the layer was added LO Copyright ©2019 John Wiley & Sons, Inc 74 Fluctuating Prices Comparison of Effects of Price Assumptions Difference between the L I F O approach (stable prices) and the dollar-value L I F O method LIFO (stable prices) LIFO (fluctuating prices) Beginning inventory $27,000 $27,000 Increment 7,700 3,920 Ending inventory $34,700 $30,920 The difference of $3,780 results from an increase in the price of goods, not from an increase in the quantity of goods LO Copyright ©2019 John Wiley & Sons, Inc 75 Subsequent Adjustments Under DollarValue L I FO Retail Illustration: Using the data from the previous example, assume that the retail value of the 2021 ending inventory at current prices is $64,800, the 2021 price index is 120 percent of base-year, and the cost-to-retail percentage is 75 percent LO Copyright ©2019 John Wiley & Sons, Inc 76 Subsequent Adjustments Decreased Ending Inventory at LIFO Cost Illustration: Conversely assume that in 2021 the ending inventory in base-year prices is $48,000 Compute the ending inventory at LIFO cost LO Copyright ©2019 John Wiley & Sons, Inc 77 Changing From Conventional Retail to LIFO Illustration: Hackman Clothing Store employs the conventional retail method but wishes to change to the LIFO retail method beginning in 2021 The amounts shown by the firm’s books are as follows Hakeman Clothing Store Inventory, January 1, 2020 Net purchases in 2020 Net markups in 2020 At Cost $ 5,210 47,250 Net markdowns in 2020 Sales revenue in 2020 LO Copyright ©2019 John Wiley & Sons, Inc At Retail $ 15,000 100,000 7,000 2,000 95,000 78 Conventional Retail Inventory Method LO Copyright ©2019 John Wiley & Sons, Inc 79 Conversion to LIFO Retail Inventory Method HaCkman Clothing can then quickly approximate the ending inventory for 2020 under the LIFO retail method LO Copyright ©2019 John Wiley & Sons, Inc 80 Learning Objective Compare the Accounting Procedures Related to Valuation of Inventories Under GAAP and IFRS LO Copyright ©2019 John Wiley & Sons, Inc 81 IFRS Insights Relevant Facts - Similarities LO • I F R S and G A A P account for inventory acquisitions at historical cost and evaluate inventory for L C N R V 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 I F R S and G A A P Copyright ©2019 John Wiley & Sons, Inc 82 IFRS Insights Relevant Facts - Differences LO • 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 L IFO /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) I FRS does not use a ceiling or a floor to determine lower-of-cost-or-market Copyright ©2019 John Wiley & Sons, Inc 83 IFRS Insights Relevant Facts - Differences LO • Under GAAP, if inventory is written down under the L CNRV or lower-ofcost-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 G AAP 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 Copyright ©2019 John Wiley & Sons, Inc 84 IFRS Insights On The Horizon One issue that will be difficult to resolve relates to the use of the LIFO cost flow assumption As indicated, IFRS specifically prohibits its use Conversely, the LIFO cost flow assumption is widely used in the United States because of its favorable tax advantages In addition, many argue that LIFO from a financial reporting point of view provides a better matching of current costs against revenue and therefore enables companies to compute a more realistic income LO Copyright ©2019 John Wiley & Sons, Inc 85 Copyright Copyright © 2019 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser 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 Copyright ©2019 John Wiley & Sons, Inc 86 ... Identify other inventory valuation issues Determine ending inventory by applying the gross profit method Determine ending inventory by applying the retail inventory method Explain how to report and... of Applying LCNRV Alternative Applications of LCNRV Companies usually price inventory on an item -by- item basis LO Copyright ©2019 John Wiley & Sons, Inc 12 Recording NRV Instead of Cost The following... John Wiley & Sons, Inc 28 Other Valuation Approaches Valuation at Net Realizable Value Permitted by G A A P under the following conditions: 1) A controlled market with a quoted price applicable