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Chapter 9 - Inventories: Additional valuation issues. After completing this chapter you should be able to: Describe and apply the lower-of-cost-or-market rule, explain when companies value inventories at net realizable value, explain when companies use the relative sales value method to value inventories, discuss accounting issues related to purchase commitments.
9-1 PREVIEW OF CHAPTER Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield 9-2 Inventories: Additional Valuation Issues LEARNING OBJECTIVES After studying this chapter, you should be able to: Describe and apply the lowerof costornet realizable value rule Determine ending inventory by applying the gross profit method Explain when companies value inventories at net realizable value Determine ending inventory by applying the retail inventory method Explain when companies use the relative standalone sales value method to value inventories Explain how to report and analyze inventory Discuss accounting issues related to purchase commitments 9-3 LOWEROFCOSTORNET REALIZABLE VALUE (LCNRV) A company abandons the historical cost principle when the future utility (revenueproducing ability) of the asset drops below its original cost 9-4 LO 1 LCNRV Net Realizable Value Estimated selling price in the normal course of business less 9-5 u estimated costs to complete and u estimated costs to make a sale ILLUSTRATION 91 Computation of Net Realizable Value LO 1 LCNRV Net Realizable Value 9-6 ILLUSTRATION 92 LCNRV Disclosures LO 1 LCNRV ILLUSTRATION 93 Determining Final Inventory Value Illustration of LCNRV: JinnFeng Foods computes its inventory at LCNRV (amounts in thousands) 9-7 LO 1 LCNRV Methods of Applying LCNRV 9-8 ILLUSTRATION 94 Alternative Applications of LCNRV LO 1 LCNRV Methods of Applying LCNRV uIn most situations, companies price inventory on an itemby item basis. uTax rules in some countries require that companies use an individualitem basis. uIndividualitem approach gives the lowest valuation for statement of financial position purposes. uMethod should be applied consistently from one period to another 9-9 LO 1 Recording Net Realizable Value Illustration: Data for Ricardo Company Cost of goods sold (before adj. to NRV) Ending inventory (cost) Ending inventory (at NRV) Loss Method COGS Method 9-10 Loss Due to Decline to NRV €108,000 82,000 70,000 12,000 Inventory (€82,000 €70,000) 12,000 Cost of Goods Sold 12,000 Inventory 12,000 LO 1 RETAIL INVENTORY METHOD 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) Regulating quantities of merchandise on hand. 4) Insurance information Some companies refine the retail method by computing inventory separately by departments or class of merchandise with similar gross profits 9-53 LO 6 Inventories: Additional Valuation Issues LEARNING OBJECTIVES After studying this chapter, you should be able to: Describe and apply the lowerofcost ornet realizable value rule Determine ending inventory by applying the gross profit method Explain when companies value inventories at net realizable value Determine ending inventory by applying the retail inventory method Explain when companies use the relative standalone sales value method to value inventories Explain how to report and analyze inventory Discuss accounting issues related to purchase commitments 9-54 PRESENTATION AND ANALYSIS Presentation of Inventories Accounting standards require disclosure of: 1) 2) 3) 4) 9-55 Accounting policies adopted in measuring inventories, including the cost formula used (weightedaverage, FIFO) Total carrying amount of inventories and the carrying amount in classifications (merchandise, production supplies, raw materials, work in progress, and finished goods) Carrying amount of inventories carried at fair value less costs to sell. Amount of inventories recognized as an expense during the period LO 7 PRESENTATION AND ANALYSIS Presentation of Inventories Accounting standards require disclosure of: 5) 6) 7) 9-56 Amount of any writedown of inventories recognized as an expense in the period and the amount of any reversal of writedowns recognized as a reduction of expense in the period Circumstances or events that led to the reversal of a writedown of inventories Carrying amount of inventories pledged as security for liabilities, if any LO 7 PRESENTATION AND ANALYSIS Analysis of Inventories Common ratios used in the management and evaluation of inventory levels are inventory turnover and average days to sell the inventory 9-57 LO 7 PRESENTATION AND ANALYSIS Inventory Turnover Measures the number of times on average a company sells the inventory during the period. Illustration: In its 2013 annual report Tate & Lyle plc (GBR) reported a beginning inventory of £450 million, an ending inventory of £510 million, and cost of goods sold of £2,066 million for the year. Illustration 925 9-58 LO 7 PRESENTATION AND ANALYSIS Average Days to Sell Inventory Measure represents the average number of days’ sales for which a company has inventory on hand Illustration 925 Average Days to Sell 365 days / 4.30 times = every 84.8 days 9-59 LO 7 GLOBAL ACCOUNTING INSIGHTS INVENTORIES In most cases, IFRS and U.S GAAP related to inventory are the same The major differences are that IFRS prohibits the use of the LIFO cost flow assumption and records market in the LCNRV differently 9-60 GLOBAL ACCOUNTING INSIGHTS Relevant Facts Following are the key similarities and differences between U.S GAAP and IFRS related to inventories Similarities • • 9-61 U.S GAAP and IFRS account for inventory acquisitions at historical cost and evaluate inventory for lower-of-cost-or-net realizable value (market) 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 U.S GAAP and IFRS GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences • • 9-62 U.S GAAP provides more detailed guidelines in inventory accounting The requirements for accounting for and reporting inventories are more principles-based under IFRS A major difference between U.S GAAP and IFRS relates to the LIFO cost flow assumption U.S 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 GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences • • 9-63 In the lower-of-cost-or-market test for inventory valuation, U.S GAAP 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 defines market as net realizable value and does not use a ceiling or a floor to determine market Under U.S GAAP, if inventory is written down under the lower-of-cost-ormarket valuation, the new basis is now considered its cost As a result, the inventory may not be written up back 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 GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences • 9-64 IFRS requires both biological assets and agricultural produce at the point of harvest to be reported at net realizable value U.S 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 GLOBAL ACCOUNTING INSIGHTS About The Numbers Presented below is a disclosure under U.S GAAP related to inventories, which reflects application of U.S GAAP to its inventories 9-65 GLOBAL ACCOUNTING INSIGHTS On the Horizon One convergence 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 9-66 COPYRIGHT Copyright © 2014 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright 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 backup 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 9-67 ...PREVIEW OF CHAPTER Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield 9- 2 Inventories: Additional Valuation Issues LEARNING OBJECTIVES After studying this chapter, you should be able to:... purchasing 420 milking cows for €460,000. Bancroft provides the ILLUSTRATION 9 9 following information related to the milking cows Agricultural Assets— Bancroft Dairy 9- 24 LO 2 Agricultural Accounting at NRV ILLUSTRATION 9 9 Agricultural Assets—... 9- 30 LO 3 VALUATION BASES ILLUSTRATION 9- 10 Allocation of Costs, Using Relative Standalone Sales Value ILLUSTRATION 9- 11 Determination of Gross Profit, Using Relative Standalone Sales Value 9- 31