Chapter 9: Inventory Valuation & Estimation Techniques

Question 1

Principle of Conservatism

Answer 1

Requires the anticipation of losses but not gains

Question 2

Valuation Rule for Inventory: Lower of Cost or Market (LCM)

Answer 2

If market price declines: write down to market price and recognize a loss currently. If market price increases: ignore. Records loss in period incurred and results in a normal gross profit to be recognized in the following period.

Question 3

Implicit Assumption of LCM

Answer 3

Decrease in replacement cost indicates a decrease in economic value and a selling price decline will follow.

Question 4

Gross Profit Method

Answer 4

Used when an estimate of inventory is needed. Ex: interim reports or insurance claims. NOT acceptable for financial reporting except for interim (quarterly) reports.

Question 5

Retail Method for Inventory

Answer 5

A procedure that allows the determination of the cost (or LCM) of ending inventory based on records maintained at RETAIL VALUE (selling price).

Question 6

Advantages of Retail Method

Answer 6

Eliminates problem of maintaining detailed cost data for individual inventory items for retail companies that have high volumes; companies can estimate ending inventory without taking a physical count for quarterly reports (must for annual reports)

Question 7

Requirements of Retail Method

Answer 7

1.) Consistent relationship between cost and selling price 2.) Cost and RV of BI 3.) Cost and RV of purchases 4.) Sales for the period