Chapter 9 Flashcards
sometimes the company will sell inventory for less than cost due to ______
“after you purchase it”
inventory damage
physical deterioration
obsolescence
changes in prices levels
(all these reasons reduce ability to sell)
GAAP requires that
companies evaluate their unsold inv at the end of each reporting period
two approaches to inv write down occur when
the expected benefit of unsold inventory is estimated to have fallen below cost
- have to make an adjusting entry - inventory write down
to reduce inv and net income for the period
what inventory write down method does a company use
LCNRV
LCM
_ both of these are the two measurement approaches
depends on inv costing method it is using
- financial statements effects are the same
- difference is the amount of the inventory write-down
LCNRV
lower of cost or net realizable value
for companies that use - FIFO, AC, or any other method besides LIFO or the retail inv method
what are the financial statement effects of inventory write downs for LCNRV and LCM
reduce reported inv
reduce net income
LCM
for companies that use LIFO or retail inv method
LCNRV
NRV = estimated selling price - (costs of completion, disposal and transportation)
net is the amount a co. expects to realize (collect in cash) from the sale of inv
at the end of the year, company compares
- cost
- NRV
IF NRV is lower than cost - need AJE
Debit: COGS
Credit: Inv
- this will reduce inv from its already recorded purchase cost to the lower NRV
IF cost is lower than NRV - no AJE
- inventory reamins at recorded purchase cost
three ways to apply LCNRV
individual items
by category
by total inventory
adjusting cost to NRV
if cost if 415,000
and NRV is 395,000
credit of 20,000 to inv is the difference needed to reach 395,000
what happens if a write down is substantial/unusual
debit loss when write down
*typically will debit COGS, credit Inv
differences between US GAAP and IFRS for LCNRV
US GAAP:
- reversals are not permitted
- can be applied to individual items, inventory categorries, or entire inv
IFRS:
- if circumstances indicate than an inv write down is no longer appropriate, must be reversed
- usually applied to individual items although using inv categories is allowed under certain circumstances
LCM
have ceiling
= NRV
have floor
= NRV - normal profit margin
market should not be greater than ceiling
market should not be less than NRV/ceiling reduced by an allowance for normal profit margin
checking to see if replacement cost falls in b/w ceiling and floor
if the replacement cost falls in between C and F, that is your market value that you compare to cost
if it is below the floor, you compare your floor as your market value to your replacement cost and then to your cost
if it is above the ceiling, you compare your ceiling as your market value to your replacement cost and then to your cost
how to calcualte LCM
1) lower of cost
2) lower of market = replacement cost not above ceiling or below the floor
gross profit method
gross margin method
useful where estimates of inv are desirable
1) determining cost of inv that has been lost, destroyed, stolen
2) in estimating inv and COGS for interim reports, avoiding the expense of a physical inv count
3) in auditors’ testing of the overall reasonableness of inv amounts reported by clients
4) in budgeting and forecasting
comparing typical calculation vs for gross profit method
useful method of calc:
beg inv
+ net purchases
= GAFS
- end inv
= COGS
NOW do GP method
beg inv
+ net purchases
= GAFS
- COGS
= end inv
Gross profit
is net sales - COGS
but for gross profit method you are trying to find COGS
so you will be given GP and net sales but need to find COGS
to then find ending inv
caution with GP method
to obtain a good estimate - need the reliability of the gross profit ratio (GP/net sales)
accuracy of the estimate can be improved by grouping inv into pools of products that have similar gross profit relationships
company’s cost flow assumption should be implicitly considered when estimating the GP ratio
suspected theft or spoilage would require an adjustment to estimates obtained using the GP method
retail inv method
used by high volume retailers selling many diff items at low unit prices
companies track purchases during the year at cost and retail prices to estimate end inv and COGS
cost = purchase cost
retail = current selling price
advantages of the retail inv method
provides a more accurate estimate than GP method
diff cost flow methods cna be incorporated into estimation technique
FIFO
LIFO
AC
can be used to estimate cost of lost, stolen, or destroyed inv
- for testing overall reasonableness of physical counts
- budgeting and forecasting and generating info for interim FS
physical count of inv is stil performed at least once a year to verify accuracy and detect spoilage, theft, other irregularities
initial markup
orginial amount of markup from cost to selling price
additional markup
increase in seling price subsequent to initial markup
markup cancellation
elimination of an additional markup
markdown
decrease in selling price subsequent to initial markup
markdown cancellation
elimination of a markdown
net markups
original cost 6
retaill/selling price 10
so initial markup is 4
if raise selling price to 13
additional markup is 3
if lower selling price to 12
markup cancellation of 1
so net markup = 2 (additional markup - markup cancellation)
net markdown
orginal cost 6
selling for 10
initial markup is 4
lower selling price to 7
markdown of 3
if raise selling price to 8
have a markdown cancellation of 1
so net markdown = 2 (markdown - markdown cancellation)
major difference for the conventional retial method
you have to exclude net markdowns until after calculating cost-to-retail %
LIFO retail method
when there is a net increase in inv quantity, LIFO results in ending inv that includes the beginning inv as well as one/more additional layers added during the period
when there is a net decrease in inv quantity, LIFO layers are liquidated
what assumption is made in LIFO retail method
assume that the retail prices of goods remained stables during the period
compare beginning and end inv in dollars to determine if quantity has increased or decreased
dollar value LIFO retail
when end inv exceeds beg inv
this “exceeds” in inv - is the new LIFO layer added or increase in retail prices
each layer year carries its unique retail price index and cost-to-retail %
change in inv method
most are retrospective:
1) revise comparative statements
2) adjust affected amounts
3) disclose additional info
change to LIFO method
- used from point the change is adopted and that period’s beginning balance is considered as the base year of inventory
switching from average cost method to FIFO
end inv 2023 was 123k
if company used FIFO 2023 end inv would have been 146,000
so would increase inv
debit: inv 23k
credit: RE 23k
can you calculate changing to LIFO method
impossible to calc the income effect on prior years
- would require assumptions as to when specific LIFO inv layers were created in prior yrs
usually not reported retrospectively
- LIFO used from that point on
- base yr inv is the beginning inv in the year the LIFO method is adopted
inventory errors
overstatment or under of end inv
1) mistake in physical count or pricing
2) mistake in recording purchases
will look at effect on COGS, NI, and RE
error in the same acct period
- Original erroneous entry should be reversed.
- Appropriate entry recorded.
error discovered in subsequent acct period
Previous year financial statement should be retrospectively
restated.
* Incorrect account balances are corrected by journal entry.
* Correction of retained earnings is reported as a prior period
adjustment to the beginning balance in the statement of
shareholders’ equity.
* Disclosure note describing the nature and impact of error
inventory error corrections
STUDY
have to read between difference for error in 2024
could be asking what will be O or U in 2024 or 2025
earnings quality
inv write down often cited as method used in shift b/w income periods
by overstating write-downs, profits are increased in future periods as the inv is used/sold
financial analyst should carefully consider the effect of any significant asset write down on the assessment of a company’s permanent earnings
