Kế toán, kiểm toán - Inventories: Additional valuation issues

PREVIEW OF CHAPTERIntermediate AccountingIFRS 2nd EditionKieso, Weygandt, and Warfield 9Determine ending inventory by applying the gross profit method.Determine ending inventory by applying the retail inventory method.Explain how to report and analyze inventory.After studying this chapter, you should be able to:Inventories: Additional Valuation Issues9LEARNING OBJECTIVESDescribe and apply the lower-of-cost-or-net realizable value rule.Explain when companies value inventories at net realizable value.Explain when companies use the relative standalone sales value method to value inventories.Discuss accounting issues related to purchase commitments.A company abandons the historical cost principle when the future utility (revenue-producing ability) of the asset drops below its original cost.LOWER-OF-COST-OR-NET REALIZABLEVALUE (LCNRV)LO 1Net Realizable ValueEstimated selling price in the normal course of business less estimated costs to complete and estimated costs to make a sale.LCNRVILLUSTRATION 9-1Computation of NetRealizable ValueLO 1ILLUSTRATION 9-2LCNRV DisclosuresNet Realizable ValueLCNRVLO 1Illustration of LCNRV: Jinn-Feng Foods computes its inventory at LCNRV (amounts in thousands).LCNRVILLUSTRATION 9-3Determining Final Inventory ValueLO 1Methods of Applying LCNRVLCNRVILLUSTRATION 9-4Alternative Applicationsof LCNRVLO 1In most situations, companies price inventory on an item-by-item basis. Tax rules in some countries require that companies use an individual-item basis. Individual-item approach gives the lowest valuation for statement of financial position purposes. Method should be applied consistently from one period to another.Methods of Applying LCNRVLCNRVLO 1Cost of goods sold (before adj. to NRV) €108,000 Ending inventory (cost) 82,000Ending inventory (at NRV) 70,000Inventory (€82,000 - €70,000) 12,000Loss Due to Decline to NRV 12,000Inventory 12,000Cost of Goods Sold 12,000LossMethodCOGSMethodIllustration: Data for Ricardo CompanyRecording Net Realizable ValueLO 1Partial Statement of Financial PositionRecording Net Realizable ValueLO 1Income StatementRecording Net Realizable ValueUse of an AllowanceInstead of crediting the Inventory account for net realizable value adjustments, companies generally use an allowance account.Loss Due to Decline to NRV 12,000 Allowance to Reduce Inventory to NRV 12,000Loss MethodLCNRVLO 1Use of an AllowancePartial Statement of Financial PositionLO 1Recovery of Inventory LossAmount of write-down is reversed.Reversal limited to amount of original write-down. Continuing the Ricardo example, assume the net realizable value increases to €74,000 (an increase of €4,000). Ricardo makes the following entry, using the loss method.Recovery of Inventory Loss 4,000Allowance to Reduce Inventory to NRV 4,000LCNRVLO 1Allowance account is adjusted in subsequent periods, such that inventory is reported at the LCNRV.Illustration shows net realizable value evaluation for Vuko Company and the effect of net realizable value adjustments on income.Recovery of Inventory LossILLUSTRATION 9-8Effect on Net Income of Adjusting Inventory to Net Realizable ValueLO 1LCNRV rule suffers some conceptual deficiencies:A company recognizes decreases in the value of the asset and the charge to expense in the period in which the loss in utility occurs—not in the period of sale. Application of the rule results in inconsistency because a company may value the inventory at cost in one year and at net realizable value in the next year.LCNRV values the inventory in the statement of financial position conservatively, but its effect on the income statement may or may not be conservative. Net income for the year in which a company takes the loss is definitely lower. Net income of the subsequent period may be higher than normal if the expected reductions in sales price do not materialize.Evaluation of LCM RuleLO 1P9-1: Remmers Company manufactures desks. Most of the company’s desks are standard models and are sold on the basis of catalog prices. At December 31, 2015, the following finished desks appear in the company’s inventory.LCNRVInstructions: At what amount should the desks appear in the company’s December 31, 2015, inventory, assuming that the company has adopted a lower-of-FIFO-cost-or-net realizable value approach for valuation of inventories on an individual-item basis?LO 1P9-1: Remmers Company manufactures desks. Most of the company’s desks are standard models and are sold on the basis of catalog prices. At December 31, 2015, the following finished desks appear in the company’s inventory.LCNRVLO 1Determine ending inventory by applying the gross profit method.Determine ending inventory by applying the retail inventory method.Explain how to report and analyze inventory.After studying this chapter, you should be able to:Inventories: Additional Valuation Issues9LEARNING OBJECTIVESDescribe and apply the lower-of-cost-or-net realizable value rule.Explain when companies value inventories at net realizable value.Explain when companies use the relative standalone sales value method to value inventories.Discuss accounting issues related to purchase commitments.Special Valuation SituationsDeparture from LCNRV rule may be justified in situations when cost is difficult to determine, items are readily marketable at quoted market prices, and units of product are interchangeable.Two common situations in which NRV is the general rule:Agricultural assetsCommodities held by broker-traders.VALUATION BASESLO 2Agricultural InventoryBiological asset (classified as a non-current asset) is a living animal or plant, such as sheep, cows, fruit trees, or cotton plants. Biological assets are measured on initial recognition and at the end of each reporting period at fair value less costs to sell (NRV). Companies record gain or loss due to changes in NRV of biological assets in income when it arises.Special Valuation SituationsNRVLO 2Agricultural InventoryAgricultural produce is the harvested product of a biological asset, such as wool from a sheep, milk from a dairy cow, picked fruit from a fruit tree, or cotton from a cotton plant.Agricultural produce are measured at fair value less costs to sell (NRV) at the point of harvest. Once harvested, the NRV becomes cost.NRVSpecial Valuation SituationsLO 2Illustration: Bancroft Dairy produces milk for sale to local cheese-makers. Bancroft began operations on January 1, 2015, by purchasing 420 milking cows for €460,000. Bancroft provides the following information related to the milking cows.Agricultural Accounting at NRVILLUSTRATION 9-9Agricultural Assets—Bancroft DairyLO 2Bancroft makes the following entry to record the change in carrying value of the milking cows.Biological Asset (milking cows) 33,800 Unrealized Holding Gain or Loss—Income 33,800Agricultural Accounting at NRVILLUSTRATION 9-9Agricultural Assets—Bancroft DairyLO 2 Unrealized Holding Gain or Loss—Income 33,800 Biological Asset (milking cows) 33,800Reported on the Statement of financial position as a non-current asset at fair value less costs to sell (net realizable value). Reported as “Other income and expense” on the income statement. Agricultural Accounting at NRVLO 2Inventory (milk) 36,000 Unrealized Holding Gain or Loss—Income 36,000Illustration: Bancroft makes the following summary entry to record the milk harvested for the month of January.Assuming the milk harvested in January was sold to a local cheese-maker for €38,500, Bancroft records the sale as follows.Agricultural Accounting at NRVCash 38,500 Sales Revenue 38,500Cost of Goods Sold 36,000 Inventory (milk) 36,000LO 2Commodity Broker-TradersGenerally measure their inventories at fair value less costs to sell (NRV), with changes in NRV recognized in income in the period of the change. Buy or sell commodities (such as harvested corn, wheat, precious metals, heating oil). Primary purpose is to sell the commodities in the near term and generate a profit from fluctuations in price. NRVSpecial Valuation SituationsLO 2Determine ending inventory by applying the gross profit method.Determine ending inventory by applying the retail inventory method.Explain how to report and analyze inventory.After studying this chapter, you should be able to:Inventories: Additional Valuation Issues9LEARNING OBJECTIVESDescribe and apply the lower-of-cost-or-net realizable value rule.Explain when companies value inventories at net realizable value.Explain when companies use the relative standalone sales value method to value inventories.Discuss accounting issues related to purchase commitments.Valuation Using Relative Standalone Sales ValueUsed when buying varying units in a single lump-sum purchase.Illustration: Woodland Developers purchases land for $1 million that it will subdivide into 400 lots. These lots are of different sizes and shapes but can be roughly sorted into three groups graded A, B, and C. As Woodland sells the lots, it apportions the purchase cost of $1 million among the lots sold and the lots remaining on hand. Calculate the cost of lots sold and gross profit.VALUATION BASESLO 3ILLUSTRATION 9-10Allocation of Costs, Using Relative Standalone Sales ValueILLUSTRATION 9-11Determination of Gross Profit, Using Relative Standalone Sales ValueVALUATION BASESLO 3Determine ending inventory by applying the gross profit method.Determine ending inventory by applying the retail inventory method.Explain how to report and analyze inventory.After studying this chapter, you should be able to:Inventories: Additional Valuation Issues9LEARNING OBJECTIVESDescribe and apply the lower-of-cost-or-net realizable value rule.Explain when companies value inventories at net realizable value.Explain when companies use the relative standalone sales value method to value inventories.Discuss accounting issues related to purchase commitments.Generally seller retains title to the merchandise.Buyer recognizes no asset or liability. If material, the buyer should disclose contract details in note in the financial statements.If the contract price is greater than the market price, and the buyer expects that losses will occur when the purchase is effected, the buyer should recognize a liability and corresponding loss in the period during which such declines in market prices take place.Purchase Commitments—A Special ProblemVALUATION BASESLO 4Illustration: Apres Paper Co. signed timber-cutting contracts to be executed in 2016 at a price of €10,000,000. Assume further that the market price of the timber cutting rights on December 31, 2015, dropped to €7,000,000. Apres would make the following entry on December 31, 2015.Unrealized Holding Gain or Loss—Income 3,000,000 Purchase Commitment Liability 3,000,000Other expenses and losses in the Income statement.Current liabilities on the balance sheet.Purchase CommitmentsLO 4Purchases (Inventory) 7,000,000Purchase Commitment Liability 3,000,000 Cash 10,000,000Assume Apres is permitted to reduce its contract price and therefore its commitment by €1,000,000. Purchase Commitment Liability 1,000,000 Unrealized Holding Gain or Loss—Income 1,000,000Illustration: When Apres cuts the timber at a cost of €10 million, it would make the following entry.Purchase CommitmentsLO 4Determine ending inventory by applying the gross profit method.Determine ending inventory by applying the retail inventory method.Explain how to report and analyze inventory.After studying this chapter, you should be able to:Inventories: Additional Valuation Issues9LEARNING OBJECTIVESDescribe and apply the lower-of-cost-or-net realizable value rule.Explain when companies value inventories at net realizable value.Explain when companies use the relative standalone sales value method to value inventories.Discuss accounting issues related to purchase commitments.Substitute Measure to Approximate InventoryRelies on three assumptions:Beginning inventory plus purchases equal total goods to be accounted for.Goods not sold must be on hand.The sales, reduced to cost, deducted from the sum of the opening inventory plus purchases, equal ending inventory.GROSS PROFIT METHOD OF ESTIMATING INVENTORYLO 5Illustration: Cetus Corp. has a beginning inventory of €60,000 and purchases of €200,000, both at cost. Sales at selling price amount to €280,000. The gross profit on selling price is 30 percent. Cetus applies the gross margin method as follows.GROSS PROFIT METHODILLUSTRATION 9-13Application of Gross Profit MethodLO 5Illustration: In Illustration 9-13, the gross profit was a given. But how did Cetus derive that figure? To see how to compute a gross profit percentage, assume that an article cost €15 and sells for €20, a gross profit of €5.Computation of Gross Profit PercentageGROSS PROFIT METHODILLUSTRATION 9-14Computation of GrossProfit PercentageLO 5Illustration 9-15 Formulas Relating to Gross ProfitIllustration 9-16Application of Gross Profit FormulasGROSS PROFIT METHODIllustration: Astaire Company uses the gross profit method to estimate inventory for monthly reporting purposes. Presented below is information for the month of May.Inventory, May 1 € 160,000 Sales € 1,000,000Purchases (gross) 640,000 Sales returns 70,000Freight-in 30,000 Purchases discounts 12,000Instructions:(a) Compute the estimated inventory at May 31, assuming that the gross profit is 25% of sales.(b) Compute the estimated inventory at May 31, assuming that the gross profit is 25% of cost.GROSS PROFIT METHODLO 5(a) Compute the estimated inventory at May 31, assuming that the gross profit is 25% of sales.GROSS PROFIT METHODLO 5(b) Compute the estimated inventory at May 31, assuming that the gross profit is 25% of cost.GROSS PROFIT METHOD25%100% + 25%= 20% of salesLO 5DisadvantagesProvides an estimate of ending inventory.Uses past percentages in calculation.A blanket gross profit rate may not be representative.Normally unacceptable for financial reporting purposes because it provides only an estimate.IFRS requires a physical inventory as additional verification of the inventory indicated in the records.Evaluation of Gross Profit MethodGROSS PROFIT METHODLO 5Managers and analysts closely follow gross profits. A small change in the gross profit rate can significantly affect the bottom line. For example, at one time, Apple Computer (USA) suffered a textbook case of shrinking gross profits. In response to pricing wars in the personal computer market, Apple had to quickly reduce the price of its signature Macintosh computers—reducing prices more quickly than it could reduce its costs. As a result, its gross profit rate fell from 44 percent in 1992 to 40 percent in 1993. Though the drop of 4 percent seems small, its impact on the bottom line caused Apple’s share price to drop from $57 per share to $27.50 in just six weeks.WHAT’S YOUR PRINCIPLETHE SQUEEZEAs another example, Debenham (GBR), the second largest department store in the United Kingdom, experienced a 14 percentage share price decline. The cause? Markdowns on slow-moving inventory reduced its gross margin. On the positive side, an increase in the gross profit rate provides a positive signal to the market. For example, just a 1 percent boost in Dr. Pepper’s (USA) gross profit ratecheered the market, indicating the company was able to avoid the squeeze of increased commodity costs by raising its prices.Sources: Alison Smith, “Debenham’s Shares Hit by Warning,” Financial Times (July 24, 2002), p. 21; and D. Kardous, “Higher Pricing Helps Boost Dr. Pepper Snapple’s Net,” Wall Street Journal Online (June 5, 2008).LO 5Determine ending inventory by applying the gross profit method.Determine ending inventory by applying the retail inventory method.Explain how to report and analyze inventory.After studying this chapter, you should be able to:Inventories: Additional Valuation Issues9LEARNING OBJECTIVESDescribe and apply the lower-of-cost-or-net realizable value rule.Explain when companies value inventories at net realizable value.Explain when companies use the relative standalone sales value method to value inventories.Discuss accounting issues related to purchase commitments.Method used by retailers to compile inventories at retail prices. Retailer can use a formula to convert retail prices to cost.Requires retailers to keep a record of:Total cost and retail value of goods purchased. Total cost and retail value of the goods available for sale.Sales for the period.MethodsConventional Method (or LCNRV)Cost MethodRETAIL INVENTORY METHODLO 6LO 6Illustration: The following data pertain to a single department for the month of October for Fuque Inc. Prepare a schedule computing retail inventory using the Conventional and Cost methods.RETAIL INVENTORY METHODRETAIL INVENTORY METHODLO 6RETAIL INVENTORY METHODLO 6Freight costsPurchase returnsPurchase discounts and allowancesTransfers-inNormal shortagesAbnormal shortagesEmployee discountsSpecial Items Relating to Retail MethodWhen sales are recorded gross, companies do not recognize sales discounts.RETAIL INVENTORY METHODLO 6LO 6Special ItemsRETAIL INVENTORY METHODILLUSTRATION 9-22Conventional RetailInventory Method—Special Items IncludedUsed for the following reasons:To permit the computation of net income without a physical count of inventory.Control measure in determining inventory shortages. Regulating quantities of merchandise on hand. Insurance information.Some companies refine the retail method by computing inventory separately by departments or class of merchandise with similar gross profits.Evaluation of Retail Inventory MethodRETAIL INVENTORY METHODLO 6Determine ending inventory by applying the gross profit method.Determine ending inventory by applying the retail inventory method.Explain how to report and analyze inventory.After studying this chapter, you should be able to:Inventories: Additional Valuation Issues9LEARNING OBJECTIVESDescribe and apply the lower-of-cost-or-net realizable value rule.Explain when companies value inventories at net realizable value.Explain when companies use the relative standalone sales value method to value inventories.Discuss accounting issues related to purchase commitments.Accounting standards require disclosure of:PRESENTATION AND ANALYSISPresentation of InventoriesAccounting policies adopted in measuring inventories, including the cost formula used (weighted-average, 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 7Presentation of InventoriesAmount of any write-down of inventories recognized as an expense in the period and the amount of any reversal of write-downs recognized as a reduction of expense in the period.Circumstances or events that led to the reversal of a write-down of inventories.Carrying amount of inventories pledged as security for liabilities, if any.Accounting standards require disclosure of:PRESENTATION AND ANALYSISLO 7Common ratios used in the management and evaluation of inventory levels are inventory turnover and average days to sell the inventory.Analysis of InventoriesPRESENTATION AND ANALYSISLO 7Measures the number of times on average a company sells the inventory during the period. Inventory TurnoverIllustration 9-25Illustration: 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. PRESENTATION AND ANALYSISLO 7Measure represents the average number of days’ sales for which a company has inventory on hand.Average Days to Sell Inventory365 days / 4.30 times = every 84.8 daysAverage Days to SellPRESENTATION AND ANALYSISIllustration 9-25LO 7INVENTORIESIn 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.GLOBAL ACCOUNTING INSIGHTSRelevant FactsFollowing are the key similarities and differences between U.S. GAAP and IFRS related to inventories. SimilaritiesU.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 INSIGHTSRelevant FactsDifferencesU.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 INSIGHTSRelevant FactsDifferencesIn 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-or-market 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 INSIGHTSRelevant FactsDifferencesIFRS 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 INSIGHTSAbout The NumbersPresented below is a disclosure under U.S. GAAP related to inventories, which reflects application of U.S. GAAP to its inventories.GLOBAL ACCOUNTING INSIGHTSOn the HorizonOne 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.GLOBAL ACCOUNTING INSIGHTSCopyright © 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 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