CH 9 Flashcards
When does a company abandon historical costs
a. A company abandons the historical cost principle when the future utility ( revenue-producing ability) of the asset drops below its original cost
When a company abandons historical costs, what occurs with inventory
a. Report inventories at the lower of cost or market
The term market refers to?
a. Cost to replace the item by purchase or reproduction
When should “ departure of cost” could be justified?
a. Company should charge a loss of utility against revenues in the period in which the loss occurs , not period of sale
What is a conservative approach to inventory valuation?
a. Lower of cost or market method
Why use replacement cost to represent market value?
a. A decline in the replacement cost of an item usually reflect or predicts a decline in selling price
b. Replacement cost allows a company to maintain a consistent rate of gross profit on sales
Define Net realizable value
a. Estimated selling price in the ordinary course of business, less reasonably predictable costs of completion and disposal ( often referred to as net selling price)
Define net realizable value less a normal profit margin
a. Normal profit margin is subtracted from normal profit margin
b. The floor ( lower limit)
What is LCM or cost rule
a. A company values inventory at the lower of cot or market with market limited to an amount that is not more than NRV or less than NRV less a normal profit margin
Define upper limit( ceiling)
a. NRV of inventory
b. The highest amount at which inventory can be reported
c. Ceiling prevents overstatement of inventories and understatement of loss in the current period
Define lower limit( floor)
a. LCM rule
b. Lowest amount at which inventory can be reported
c. Computed as the NRV less a normal profit margin. This minimum amount measures what the company can receive for the inventory and still earn a normal profit
What is prevents overstatement of value of obsolete , damaged, or shopworn inventories?
a. A company should not exceed NRV’s ceiling
NRV reduced by an allowance for an approximately normal profit margin is called minimum limitation? True or False
a. True
i. The floor establishes a value below which a company should not price inventory, regardless of replacement cost
Define Designate market value
a. Amount that a company compares to cost
b. It is always the middle value of three amounts
i. In replacement cost,
ii. NRV
iii. NRV less a normal profit margin
What are the two methods used to record the income effect of valuing inventory at market
a. COGS method
b. Loss method
Define COGS method
a. A method of valuing inventory in which COGS is debited for the write down of inventory to market
i. So, company does not report a loss in the income statement because the COGS already includes the amount of loss
Define Loss method
A method of valuing inventory in which a loss account is debited for the write down of the inventory to market, as opposed to the COGS method which buries the loss in the COGS account
Instead of crediting the inventory account for market adjustments, what do companies record which account?
a. Allowance to reduce inventory to market
b. i.e., (DR) Loss Due to Decline of inventory to market
i. (CR) allowance to reduce inventory market
1. This reports both cost and the market value of inventory
What are deficiencies of LCM or cost
a. Company recognizes deceases in the value of the asset and the charge to expense in the period in which the loss in utility occur not in the period of sale
b. Application of the rule results in inconsistency because a company may value the inventory at cost in one year and at market in the next year
c. LCM or cost values the inventory in the balance sheet conservatively, but its effect on the income statement may or may not be conservative
d. Application of the LCM or cost rule uses a “ normal profit in determining inventory values
What should companies define more clearly
a. “ market” as NRV rather than replacement cost
What are limited circumstances that GAAP permits this exception to recording revenue at NRV
a. When there is a controlled market with a quoted price applicable to all quantities
b. When no significant costs of disposal are involved
c. Allowing valuation at NRV is that sometimes it is too difficult to obtain the cost figures
Define purchase commitments
a. Agreements to buy inventory weeks, months, or even years in advance
Define Hedging
a. The purchaser in the purchase commitment simultaneously enters into a contract in which it agrees to sell in the future the same quantity of the same ( or similar ) goods at a fixed price. The company holds a buy position in a purchase commitment and a sell position in a futures contract in the same commodity
24) Define Gross margin method
a. One substitute method of verifying or determining the inventory amount
What are the gross profit method’s three assumptions
a. The beginning inventory plus purchases equal total goods to be accounted for
b. Goods not sold must be on hand
c. The sales, reduced to cost, deducted from the sum of the opening inventory plus purchases equal ending inventory
Define gross profit percentage
a. Percentage of selling price
What makes quoting the profit with gross profit percentage
a. Most companies state good on a retail basis, not a cost basis
b. A profit quoted on selling price is lower than one based on cost
c. The gross profit based on selling price can never exceed 100 percent
Define Retail inventory method
a. It requires that the retailer keep a record of
i. The total cost and retail value of good purchased
ii. The total cost and retail value of the goods available for sale
iii. The sales for the period
What are the challenges that retail operations deal with?
a. There are specific inventory that have different cost assumes
b. It is difficult to track different types of retail
Define Cost to retail ratio
a. Total goods available for sale at cost divided by the total goods available for sale at retail price
What are other versions of retail method?
a. Conventional method
b. Cost method
c. LIFO retail method
d. Dollar value LIFO
What do retailers do to encourage buyers’ purchases
a. Mark up( up the price)
b. Mark downs ( decreases in the original sales prices)
Define Markup cancellations
a. Decreases in prices of merchandise that retailer had marked up above the original retail price
Define Markdown cancellations
a. Increases in prices of goods that retailer had marked down
What does the value of ending inventory approximates?
a. Lower of average cost or market
i. Also called conventional retail inventory method
What does a markup normally indicate?
a. an increase in the market value of the item
What does a markdown usually indicate?
a. Decline in the utility of item
How does a company figure their ending inventory valuation?
i. Compute cost to retail ratio
ii. Deduct markdowns
iii. Compute ending inventory at cost
1. Ending at retail times cost to retail ratio
Define Freight cost
a. Part of the purchase cost
Define Purchase returns
a. Ordinarily considered as a reduction of the price at both cost and retail
Purchase discounts and allowances
a. Considered as a reduction of the cost of purchases
What are considered as proper adjustments to gross sales
a. Sales returns and allowances
True or False, when sales are recorded as gross, companies do recognize sales discounts?
a. False, sales discounts aren’t recognized with gross sales
b. If it did, ending would be overvalued
Define Transfers-in
a. Reported in the same way as purchases from an outside company
Define Normal shortages
a. Breakage, damage, theft, shrinkage
b. Reduce the retail column because these goods are no longer available for sale
Define Employee Discounts
a. Deductions from the retail column in the same way as sales
b. Encourage loyalty, better performance, and so on
Why do big retail companies use retail inventory method
a. Permit the computation of NI without a physical count of Inv
b. Control measure in determining inv shortages
c. Regulating quantities of merch on hand
d. Insurance information
What can be problematic for retail inventory method
a. A company uses the method for entire business
i. Because there is no allowances ( comparisons) to check for possible distortions
What does What do LIFO result predict that other cost assumptions cannot?
a. Better matching
b. Revenues
What are two assumptions that LIFO retail can predict
a. Stable prices
b. Fluctuating prices
What is major assumption of LIFO retail method
a. Markups and markdowns apply to good purchased during the current period and not to the beginning inventory
How does a company remove the price change
a. Dollar value LIFO
Define Dollar value LIFO retail method
a. Method of valuing ending inventory that assumes a change in the price level of inventories which the company must eliminate so as to measure the real increase in inventory, no the dollar increase
How do you solve ending at LIFO cost
a. Retail times cost to retail ratio
How do you solve for cost to retail ratio
a. Net purch at cost / net purch at retail plus markups less markdowns.
How do you record LIFO adjustment at cost?
a. (DR) inv
b. (CR) Adjustment to record inventory at cost
