9. Inventory

Question 1

Perpetual system, inventory updated continuously after every purchase, sale, return and cogs determined for each sale. Requires detailed and complex record keeping.

Periodic system makes no adjustment to inventory until the end of the accounting period, when a physical inventory count is performed, and cogs is recorded. Company must estimate its inventory during the year ie for interim statements. Since estimates are used, the record keeping is relatively simple.

Question 2

Lower of cost or Market method
Although market value is usually a replacement cost, it is subject to a ceiling and floor limitation.
1. ceiling or NRV (sales price - cost required to complete the inventory + any disposal costs) is the maximum amount that may be reported as market
2. floor (NRV - (profit margin x #of units*)) is the lowest amount that may be reported as market
*profit margin is sale x % of sale
The Market Value is the middle value from the replacement cost, ceiling and floor cost.

Inventory adjustment is the $415 ending inventory - $410 Market value.

The lower of cost or market (LCM) rule applies only to inventory accounted for under the LIFO or retail inventory method. LCM compares the cost with the current market value of the inventory based on individual items, categories or total inventory.

** because Co is using the total inventory to apply the LMC, it must first calculate the total cost and market value of its inventory - add item 1 + item 2.
The cost (original cost) is $610 and the market value is $620 (replacement cost $620, ceiling $650 and floor $613).
The answer is $610 original cost is the lowest.

Question 3

Cost of inventory

Acquisition cost (net trade discount)
Warehousing cost
Insurance, repacking
Freight-in (paid by buyer)
Transportation of consigned goods
Costs to bring to saleable condition
Normal spoilage

Question 4

The commission paid to consignee and the advertising paid are selling expenses for the period and need to be reimbursed to consignee by in full when the revenue is recognized.

Question 5

Ending inventory overstated/understated:

Goods available for sale: NA/NA
Cost of goods sold: understated/Overstated
Gross margin (profit): Overstated/Understated
Net income: Overstated/Understated
Retained earnings: Overstated/Understated

Everything goes in the same direction as inventory, except COGS.

Question 6

Under a perpetual system, inventory is updated continuously so there is no need to estimate ending inventory.

The periodic system makes adjustments to inventory only at the end of the period; therefore inventory must be estimated during the year.

The gross profit method relies on the company’s historical gross profit percentage when estimating inventory.

Question 7

Dollar- value LIFO

Year 2 inventory $132 /1.2 index = $110
then: $110 - $100 Year 1 inventory =$10
then: $10 x 1.2 index = $12
then: $100 Year 1 + $12 =$112 reported inventory on BS.

1. Convert the current value of inventory in Base-year dollars by dividing by the current price index
2. Compare the deflated ending inventory with the prior year LIFO layer if a new layer is created or part of an older layer is used. If new layer is needed, it is restated (ie. inflated) from bas-year dollars back to current year dollars and added to the prior year’s DVL.
3. Calculate the value of the new layer x index price
4. The original inventory layer + new layer

Price index = current EI/current EI in base year dollars

Depending what is provided in the question, it may not be necessary to perform all the calculations.

Question 8

Moving forward method is perpetual system.

Question 9

FOB destination free on board destination, seller retains ownership of the goods during transportation and therefore pays for the cost (freight out). Don’t include in cost of the inventory.

The initial cost of inventory includes:
- warehousing costs prior to sale
- insurance, repackaging, modifications
- freight in paid by the buyer
- costing incurred to bring the salable condition eg. assembly

Question 10

Retail inventory method is a means of estimating ending inventory by relying on the relationship between the cost of inventory and the sales price. This method allows retailers to avoid the time and cost of taking physical inventory counts for interim reporting periods. Companies track inventory cost and retail ie. sales ) dollars. Sales, markups and markdowns are recorded in retail dollars.
At the end of the period, the inventory is converted from retail back to cost by using a cost to retail percentage. This percentage represents the cost part of each sales dollar and its calculation is dependent on the cost flow assumption applied eg. LIFO, FIFO, average cost). The conventional retail method includes net markups but excludes net markdowns.

Because Co uses the conventional method, only the net markups are included in the cost to retail percentage calculation.
Percentage = average cost/goods available for sale*
*Retail-begining inventory + markup = 70%
Beg inventory $920
+ net markups 40
Goods avail. for sale $960
- markdowns ($64)
Sales price of goods available for sale $896
- sales at retail ($780)
Ending inventory in retail dollars $116
x (672/960) 70% = $81,200.
*beginig inventory average cost $672

Question 11

During the period of rising prices, FIFO perpetual and periodic system would end with the same dollar amount.

Question 12

Example of dollar value LIFO
In Jan. Co adopted the dollar value LIFO method of inventory valuation. At adoption, inventory was valued at $50. During the year, inventory increased $30 using base year prices, and price increased 10%. The designated market value of Co’s inventory exceeded its cost at year end. What should be reposted on BS at YE?
In this scenario you start at step 3, if price increased 10% then the index is 1.1 resulting in EI of $83.

DVL layer at beginning of base year $50 x 1 = $50
Current year in base year dollars restated to current year dollars ($30x1.1) =$33
Current year EI reported $83

Question 13

**Dollar value LIFO (DVL) focuses on the dollar value of ending inventory rather than units. It applies a current-year price index to remove the effect of inflation before any change in inventory is considered. If a new LIFO layer is needed, it is restated from base-year dollars back to current-year dollars. The sum of the restated layers equals EI.

Question 14

If LIFO or the retail inventory method is used, the lower of cost or market is applied. LCM compares the inventory cost with the market value. Although market value is usually replacement cost, it is subject to ceiling and floor limitations.

For other inventory methods as FIFO or average cost a simplified LCM or NRV (LCNRV) rule applies. The LCNRV compares the inventory cost with NRV.

NRV = sales price - cost required to complete the inventory and any disposal cost

Question 15

Example question 67 conventional retail inventory method.

Data for a firm using the Average LCM retail inventory method is as follows:
Cost. Retail
Begining inventory $300. $467
Net purchase. $1,200. $2,000
Net additional markup $100
Net markdowns. ($300)
Sales. $1,700
Computer cost of good sold.
Ending inventory at retail $567 = 467+2,000+100-300-1,700)
C/R = $300 +1,200 / 457+2,000+100 =0.5843
Ending inventory at cost = 567x0.5843=331
Cost of goods sold = 300+1,200-331=1,169
Answer: $1,169

Question 16

Unsold inventory/sold inventory gives a percentage of inventory left.
Multiply that by the shipping in cost to get the amount of cost included in cost of goods sold. !!!
Thai was question 5.

Question 17

Market is equal to current replacement cost, subject to the following constraints:
1. market cannot exceed the net realizable value, and
2. market cannot be below NRV less the normal profit margin.

Question 18

Company must estimate its inventory during the year (for interim statements) if a periodic system is used.
There are two costing methods used to estimate ending inventory: retail inventory and gross profit.
- th retail inventory method uses the current cost of inventory and revenue (ie sales) to estimate ending inventory
- the gross profit method uses the company’s historical gross profit percentage (drives from prior periods financial data) to determine COGS and estimate ending inventory
Co used a perpetual system, it would no need to estimate its inventory. The company is using a periodic system. Because the method used is based on prior periods financial statements, Co must be using the gross profit method.

Perpetual:
Continuously update inventory
Know inventory amount at any point in time
Periodic:
No adjustment to inventory until the end of the period
Must estimate inventory during the year

Then - methods to estimate ending inventory
Retail inventory (current data)
Gross profit (historical data)

Question 19

Inventory: dollar value LIFO
Current year cost
Base year cost - current cost / index
Dollar value LIFO - last year + layer

Index = current year cost/base year cost

Question 20

FOB destination - seller owns goods and pays shipping; records freight-out (a seller expense)

FBO shipping point - buyer owns goods and pays shipping; records freight in (added to inventory)

Question 21

LMC method
Market value is is usually a RC which is subject to a ceiling and floor limitation.

Compare ending inventory cost with market value.

Question 22

The cost to retail percentage calculation is dependent on the cost-flow assumption applied eg LIFO, FIFO, average cost. In the conventional retail method used for FIFO and average cost, the percentage calculation includes net markups but excludes net markdowns. However, in the LIFO retail method, the cost to retail percentage includes both net markups and net markdowns but excludes beginning inventory.

Question 23

The retail inventory method includes in the calculation of both cost and retail amounts of goods available for sale the purchase returns.
Does not include in both: sales return, net markups, freight in.

Question 24

Dollar value LIFO

Question 76

Year 1 - base year cost $300
Year 2 - (base year cost Year 2 - base year cost Year 1) x index
$400 - $300 =$100
100 x 1.1 =110
Inventory at year end 2: base year cost year 1 + year 2 layer

$300 + $110 =$410.00

Question 25

When the shipment terms are FOB destination, the seller bears all costs of transporting the goods to the buyer. !!!

Question 26

Question 81
Conventional retail method of inventory valuation
cost retail
Begining inventory $12. $30
Purchases. $60. $110
Net additional markup $0. $10
Net markdowns. $0. $20
Sales revenue. $0. $90
If the lower cost or market rule is used, what would be the estimated cost of the ending inventory?

The cost to retail ratio using the retail inventory method is: $12 + $60 / $30+$110+$10 =0.48
Ending inventory at retail is $30+$110+$10-$20-$90 =$40
Ending inventory at cost, therefore is 0.48 x $40 = $19,200.

Question 27

Cash discounts permitted on purchase raw materials should be deducted from inventory whether taken or not. !!!

Question 28

Sale - markup 25% = cogs

600/1.25 = $480 cogs

Begining inventory $450
+ purchase $500
—————————————
Coat of goods available for sale $950
- cogs $480
——————————————
Ending inventory $470

Question 29

The goods returned should be recorded as a return in year 2 when it was authorized the return, not when it was revived in January 2.

Question 30

COGS is calculated as (beginning inventory + purchases - ending inventory)
Beginning inventory has a direct relationship with COGS. Thus, understated begining inventory results in understated COGS.

Ending inventory has an inverse relationship with COGS. Thus, overstated ending inventory results in understated COGS.