Chapter 9 - Inventories: Additional Valuation Issues

Question 1

In regards to the LCNRV rule, what exception does the FASB grant to companies that use the LIFO or retail inventory methods?

Answer 1

Because the change to LCNRV would result in potentially significant costs and would not simplify measurement of inventory for these companies, FASB allows them to use this alternative approach: LCM (lower-of-cost-or-market)

Companies compare a designated market value of the inventory to cost. This approach begins with replacement cost, then applies two additional limitations to value ending inventory - net realizable value less a normal profit margin. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable cost of completion and disposal. A normal profit margin is subtracted from that amount to arrive at net reasonable value less a normal profit margin.

A company values inventory at the lower-of-cost-or-market, with market limited to an amount that is not more than net realizable value or less than net realizable value less a normal profit margin (ceiling & floor).

Question 2

How do you determine the designated market value of inventory?

Answer 2

It is always the middle value of three amounts: replacement cost, net realizable value, and net realizable value less a normal profit margin.

Question 3

Under what conditions can companies record inventory at net realizable value, even if that amount is above cost?

Answer 3

1. When there is a controlled market with a quoted price applicable to all quantities, AND
2. When no significant costs of disposal are involved, AND
3. The product is available for immediate delivery.

ex. minerals (rare metals, especially), agricultural products (such as harvested crops or animals held-for-sale)

Question 4

How does IFRS compare to GAAP in regards to Inventory Valuation Issues? (2)

Answer 4

IFRS requires all companies to apply LCNRV. Thus IFRS does not use a ceiling or floor to determine market.

Similar to GAAP, certain agricultural products and mineral products can be reported at net realizable value using IFRS.

Question 5

What is inventory turnover and how is it calculated?

Answer 5

The inventory turnover measures the number of times on average a company sells the inventory during the period. It measures the liquidity of the inventory.

To compute inventory turnover, divide the cost of goods sold by the average inventory on hand during the period.