Kế toán, kiểm toán - Chapter 9: Inventories: additional issues

INVENTORIES: ADDITIONAL ISSUESChapter 9Reporting -- Lower of Cost or MarketInventories are valued at the lower-of-cost-or market.LCM is a departure from historical cost. The method causes losses to be recognized in the period the value of inventory declines below its cost rather than in the period that the goods ultimately are sold.Determining Market Value+ Estimated selling price− Cost of Completion− Cost to sell= Net Realizable Value / Market ValueIAS No. 2 defines “market value” as the net realizable value (NRV).NRV is the estimated selling price in the ordinary course of business less estimated cost of completion and disposal (cost to sell).Determining Market Value(1) Selling Price in ordinary course of business (3) Net Realizable ValueDesignatedMarketCostOrStep 1Determine Designated MarketStep 2Compare Designated Market with CostLower of CostOr Market(2) less: Estimated cost of completion and disposalLower of Cost or MarketAn item in inventory has a historical cost of $20 per unit. At year-end we gather the following per unit information: selling price = $30cost to complete and dispose = $4 How would we value this item in the statement of financial position?Lower of Cost or Market$21.50DesignatedMarket?Historical cost of $20.00 is less than the NRV of 26, so this inventory item will be valued at cost of $20.00.1. Apply LCM to each individual item in inventory. 2. Apply LCM to logical inventorycategories. 1) Individual Items2) Group of similar or related inventory itemsApplying Lower of Cost or MarketLower of cost or market can be applied 2 different ways. Adjusting Cost to MarketRecord the Loss as a Separate Item in the Income Statement Loss on write-down of inventory XX Inventory XXRecord the Loss as part of Cost of Goods Sold. Cost of goods sold XX Inventory XXReversal of Write-DownsAfter Write DownRe-assess NRV at the end of every subsequent periodWrite-Up AllowedIf current carrying value is lower than the revised NRVWrite-up allowed up to the lower of the revised NRV and original costU. S. GAAP vs. IFRSLCM requires selecting market from replacement cost, net realizable value or NRV reduced by the normal profit margin.Designated market is compared to historical cost to determine LCM.International standards require inventory to be valued at the lower of cost or market, but the process is slightly different for the U.S. method of applying LCM.IAS No. 2, states that the designated market will always be net realizable value.U. S. GAAP vs. IFRSUnder U.S. GAAP, the LCM rule can be applied to individual items, logical inventory categories, or the entire inventory.Reversals are not permitted under GAAP.International standards require inventory to be valued at the lower of cost or market, but the process is slightly different for the U.S. method of applying LCM.The LCM assessment usually is applied to individual items, although using logical inventory categories is allowed under certain circumstances.If an inventory write-down is not longer appropriate, it must be reversed.Inventory Estimation TechniquesEstimate instead of taking physical inventory Less costly Less time consumingTwo popular methods of estimating ending inventory are the . . .Gross Profit MethodRetail Inventory MethodGross Profit MethodUseful when . . .Estimating inventory and COGS for interim reports.Determining the cost of inventory lost, destroyed, or stolen.Auditors are testing the overall reasonableness of client inventories.Preparing budgets and forecasts.NOTE: The Gross Profit Method is not acceptable for use in annual financial statements.Gross Profit MethodThis method assumes that the historical gross margin ratio is reasonably constant in the short-run.Beginning Inventory (from accounting records)Plus: Net purchases (from accounting records)Goods available for sale (calculated)Less: Cost of goods sold (estimated)Ending inventory (estimated)   Estimate the Historical Gross Profit RatioGross Profit Method Matrix, Inc. uses the gross profit method to estimate end of month inventory. At the end of May, the controller has the following data: Net sales for May = $1,213,000Net purchases for May = $728,300Inventory at May 1 = $237,400 Estimated gross profit ratio = 43% of sales Estimate Inventory at May 31.Gross Profit Method NOTE: The key to successfully applying this method is a reliable Gross Profit Ratio.The Retail Inventory MethodThis method was developed for retail operations like department stores.Uses both the retail value and cost of items for sale to calculate a cost to retail percentage.Objective: Convert ending inventory at retail to ending inventory at cost.The Retail Inventory MethodTerm Meaning Initial markup Original amount of markup from cost to selling price. Additional markup Increase in selling price subsequent to initial markup. Markup cancellation Elimination of an additional markup. Markdown Reduction in selling price below the original selling price. Markdown cancellation Elimination of a markdown.Retail TerminologyThe Retail Inventory MethodWe need to know . . .Sales for the period.Beginning inventory at retail and cost.Adjustments to the original retail price.Net purchases at retail and cost.Retail TerminologyThe Retail Inventory MethodMatrix, Inc. uses the retail method to estimate inventory at the end of each month. For the month of May the controller gathers the following information: Beginning inventory at cost $27,000, at retail $45,000Net purchases at cost $180,000 at retail $300,000Net sales for May $310,000Estimate the inventory at May 31.The Retail Inventory MethodThe Retail Inventory Methodx×Retail Inventory MethodMarkups and MarkdownsMatrix, Inc. uses the retail method to estimate inventory at the end of July. The controller gathers the following information: Beginning inventory at cost $21,000 (at retail $35,000), Net purchases at cost $200,000 (at retail $304,000), Net markups $8,000, Net markdowns $4,000, And net sales for July $300,000.Estimate inventory at July 31.Retail Inventory MethodWith Markups and MarkdownsRetail Inventory MethodWith Markups and MarkdownsxThe Retail Inventory MethodNet Markdowns are excluded in the computation of the cost-to-retail percentage. This is referred to as theConventional Retail MethodWe can estimate ending inventory at average LCM using the cost-to-retail percentage shown below:Other Issues of Retail MethodElement TreatmentBefore calculating the cost-to-retail percentage   Freight-in Added to the cost column Purchase returns Deducted in both the cost and retail columns Purchase discounts taken Deducted in the cost column Abnormal shortage, spoilage, or theft Deducted in both the cost and retail columnsAfter calculating the cost-to-retain percentage   Normal shortage, spoilage, or theft Deducted in the retail column Employee discounts Added to net salesChanges in Inventory MethodRecall that most voluntary changes in accounting principles are reported retrospectively. This means reporting all previous periods’ financial statements as though the new method had been used in all prior periods.Changes in inventory methods, Except when it is impracticable to determine either the period-specific effects or the cumulative effects of the changes, are treated retrospectively.Change To The LIFO MethodWhen a company elects to change to LIFO, it is usually impossible to calculate the income effect on prior years. As a result, the company does not report the change retrospectively. Instead, the LIFO method is used from the point of adoption forward.A disclosure note is needed to explain (a) thenature of the change; (b) the effect of thechange on current year’s income andearnings per share, and (c) why retrospective application was impracticable.Analyzing Inventory ErrorsInventory Errors Overstatement of ending inventoryUnderstates cost of goods sold andOverstates pretax income. Understatement of ending inventoryOverstates cost of goods sold andUnderstates pretax income.Inventory ErrorsOverstatement of beginning inventoryOverstates cost of goods sold andUnderstates pretax income.Understatement of beginning inventoryUnderstates cost of goods sold andOverstates pretax income.Inventory ErrorsWhen the Inventory Error is Discovered the Following YearIf an error was made in 2012, but not discovered until 2013, the 2012 financial statements were incorrect as a result of the error. The error should be retrospectively restated to reflect the correct inventory amount, cost of goods sold, net income, and retained earnings when the comparative 2012 and 2013 financial statements are issued in 2013.When the Inventory Error is Discovered Subsequentto the Following YearIf an error was made in 2012, but not discovered until 2014, the 2013 financial statements also are retrospectively restated to reflect the correct cost of goods sold and net income even though no correcting entry is needed. The error has self-corrected and no prior period adjustment is needed.Inventory ErrorsOverstatement of purchasesOverstates cost of goods sold andUnderstates pretax income.Understatement of purchasesUnderstates cost of goods sold andOverstates pretax income.Earnings QualityMany believe that manipulating income reduces earnings quality because it can mask permanent earnings. Inventory write-downs and changes in inventory method are two additional inventory-related techniques a company could use to manipulate earnings. Appendix 9ADetermining Value Under U.S. GAAPDetermining Market ValueMarket Should Not Exceed Net RealizableValue (Ceiling)Market Should Not Be Less Than Net Realizable Value less Normal Profit (Floor)GAAP defines “market value” in terms of current replacement cost.Market should not be greater than the “ceiling” or less than the “floor.”Determining Market ValueCeilingNRVReplacementCostNRV – NPFloorDesignatedMarketCostNot More ThanNot Less ThanOrStep 1Determine Designated MarketStep 2Compare Designated Market with CostLower of CostOr MarketLower of Cost or MarketAn item in inventory has a historical cost of $20 per unit. At year-end we gather the following per unit information: current replacement cost = $21.50selling price = $30cost to complete and dispose = $4 normal profit margin of = $5How would we value this item in the Balance Sheet?Lower of Cost or MarketReplacementCost =$21.50 $21.50DesignatedMarket?Historical cost of $20.00 is less than designated market of $21.50, so this inventory item will be valued at cost of $20.00. Appendix 9BLIFO Retail MethodThe Retail Inventory MethodAssume that retail prices of goods remain stable during the period.Establish a LIFO base layer (beginning inventory) and add (or subtract) the layer from the current period.Calculate the cost-to-retail percentage for beginning inventory and for adjusted net purchases for the period. The LIFO Retail MethodThe Retail Inventory MethodBeginning inventory has its owncost-to-retail percentage.The LIFO Retail Method   LIFO Cost-=Net Purchasesto-Retail %Retail Value (Net Purchases  + Net Markups - Net Markdowns)   Retail Inventory MethodLIFO RetailRetail Inventory MethodLIFO RetailRetail Inventory MethodLIFO Retail Appendix 9CDollar-Value LIFO RetailDollar-Value LIFO RetailWe need to eliminate the effect of any price changes before we compare the ending inventory with the beginning inventory.Dollar-Value LIFO RetailReturn to our earlier Matrix Inc. example to estimate the ending inventory using dollar-value LIFO retail. Recall that ending inventory was estimated to be $35,000 at retail, and $21,000 at cost with a 60% gross profit ratio.Net purchases at cost $200,000, at retail $304,000.Net markups $8,000.Net markdowns $4,000.Net sales for June $300,000.Price index at June 1 is 100 and at June 30the index is 102. Dollar-Value LIFO Retail Appendix 9DPurchaseCommitmentsPurchase CommitmentsPurchase commitments are contracts that obligate a company to purchase a specified amount of merchandise or raw materials at specified prices on or before specified dates.In July 2013, the Lassiter Company. signed two purchase commitments.The first requires Lassiter to purchase inventory for $500,000 byNovember 15, 2013. The inventory is purchased on November 14, andpaid for on December 15. On the date of acquisition, the inventory had a market value of $425,000. The second requires Lassiter to purchase inventory for $600,000 by February 15, 2014. On December 31, 2013,the market value of the inventory items was $540,000. OnFebruary 15, 2014, the market value of the inventory items was$510,000. Lassiter uses the perpetual inventory system and is acalendar year-end company. Let’s make the journal entries for these commitments.Purchase CommitmentsSingle-period commitmentNovember 14, 2013Inventory (market price) 425,000Loss on purchase commitment 75,000 Accounts payable 500,000December 15, 2013Accounts payable 500,000 Cash 500,000Multi-period commitmentDecember 31, 2013Estimated loss on commitment 60,000 Estimated liability on commitment 60,000 February 15, 2014Inventory (market price) 510,000Loss on purchase commitment 30,000Estimated liability on commitment 60,000 Cash 600,000End of Chapter 9