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Chapter 9 inventories: additional issues Sommers ACCT 3311

Discussion Questions. Q9?19 Identify any differences between U.S. GAAP and IFRS when applying the lower-of-cost-or-market rule to inventory valuation.. U.S. GAAP vs. IFRS. LCM requires selecting market from replacement cost, net realizable value or NRV reduced by the normal profit margin.Designated

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Chapter 9 inventories: additional issues Sommers ACCT 3311

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    1. Chapter 9 inventories: additional issues Sommers – ACCT 3311 Chapter 1: Environment and Theoretical Structure of Financial Accounting.Chapter 1: Environment and Theoretical Structure of Financial Accounting.

    2. Discussion Questions Q9–19 Identify any differences between U.S. GAAP and IFRS when applying the lower-of-cost-or-market rule to inventory valuation.

    3. U.S. GAAP vs. IFRS Part I International standards require inventory to be valued at the lower of cast or market, but the process is slightly different for the U.S. method of applying LCM. Part II From the perspective of the FASB, LCM requires selecting market from replacement cost, net realizable value or NRV reduced by the normal profit margin. Designated market is compared to historical cost to determine LCM. However, IAS No. 2, states that the designated market will always be net realizable value. Part I International standards require inventory to be valued at the lower of cast or market, but the process is slightly different for the U.S. method of applying LCM.

    4. U.S. GAAP vs. IFRS Part I International standards require inventory to be valued at the lower of cast or market, but the process is slightly different for the U.S. method of applying LCM. Part II From the perspective of the FASB, Under U.S. GAAP, the LCM rule can be applied to individual items, logical inventory categories, or the entire inventory. If an inventory write-down is not longer appropriate, it must be reversed. However, according to the IFRS: The LCM assessment usually is applied to individual items, although using logical inventory categories is allowed under certain circumstances. Allows companies to reverse write-downs later if NRV increases. Part I International standards require inventory to be valued at the lower of cast or market, but the process is slightly different for the U.S. method of applying LCM.

    5. P9-7 Smith-Kline Company maintains inventory records at selling prices as well as at cost. For 2011, the records indicate the following data: Cost Retail Beginning inventory $ 80 $ 125 Purchases 671 1,006 Freight-in on purchases 30 Purchase returns 1 2 Net markups 4 Net markdowns 8 Net sales 916 Use the average cost retail method to approximate cost of ending inventory.

    6. P9-7 (Average Cost Retail)

    7. P9-7 Smith-Kline Company maintains inventory records at selling prices as well as at cost. For 2011, the records indicate the following data: Cost Retail Beginning inventory $ 80 $ 125 Purchases 671 1,006 Freight-in on purchases 30 Purchase returns 1 2 Net markups 4 Net markdowns 8 Net sales 916 Use the conventional retail method to approximate cost of ending inventory.

    8. P9-7 (Conventional Retail)

    9. Discussion Questions Q9–14 Explain the difference between the retail inventory method using LIFO and the dollar-value LIFO retail method.

    10. Dollar-Value LIFO Retail We need to eliminate the effect of any price changes before we compare the ending inventory with the beginning inventory. The purpose of dollar-value LIFO retail is to eliminate the effects of price changes on ending inventory and beginning inventory.The purpose of dollar-value LIFO retail is to eliminate the effects of price changes on ending inventory and beginning inventory.

    11. P9-8 Smith-Kline Company maintains inventory records at selling prices as well as at cost. For 2011, the records indicate the following data: Cost Retail Beginning inventory $ 80 $ 125 Purchases 671 1,006 Freight-in on purchases 30 Purchase returns 1 2 Net markups 4 Net markdowns 8 Net sales 916 Assuming the price level increased from 1.00 at January 1 to 1.10 at December 31, 2011, use the dollar-value LIFO retail method to approximate cost of ending inventory and cost of goods sold.

    12. P9-8

    13. P9-8

    14. Analyzing Inventory Errors Let’s discuss this in detail as a part of Chapter 20 When analyzing inventory errors, it’s helpful to visualize the way cost of goods sold, net income, and retained earnings are determined Beginning inventory and net purchases are added in the calculation of cost of goods sold. If either of these is overstated (understated) then cost of goods sold would be overstated (understated). On the other hand, ending inventory is deducted in the calculation of cost of goods sold, so if ending inventory is overstated (understated) then cost of goods sold is understated (overstated). Of course, errors that affect income also will affect income taxes. In the illustration that follows, we ignore the tax effects of the errors and focus on the errors themselves rather than their tax aspects.When analyzing inventory errors, it’s helpful to visualize the way cost of goods sold, net income, and retained earnings are determined Beginning inventory and net purchases are added in the calculation of cost of goods sold. If either of these is overstated (understated) then cost of goods sold would be overstated (understated). On the other hand, ending inventory is deducted in the calculation of cost of goods sold, so if ending inventory is overstated (understated) then cost of goods sold is understated (overstated). Of course, errors that affect income also will affect income taxes. In the illustration that follows, we ignore the tax effects of the errors and focus on the errors themselves rather than their tax aspects.

    15. Purchase Commitments Purchase commitments are contracts that obligate a company to purchase a specified amount of merchandise or raw materials at specified prices on or before specified dates. In July 2011, the Lassiter Company. signed two purchase commitments. The first requires Lassiter to purchase inventory for $500,000 by November 15, 2011. The inventory is purchased on November 14, and paid for on December 15. On the date of acquisition, the inventory had a market value of $425,000. The second requires Lassiter to purchase inventory for $600,000 by February 15, 2012. On December 31, 2011, the market value of the inventory items was $540,000. On February 15, 2012, the market value of the inventory items was $510,000. Lassiter uses the perpetual inventory system and is a calendar year-end company. A purchase commitment is a contract between two parties, requiring one of the parties to purchase a specified amount of inventory at a set price, on or before a particular date. Read through the example of the two purchase commitments entered into by Matrix in July of 2009. We will look at the accounting for both of these purchase commitments. It is important to note that one of the purchase commitments requires action during 2009, while the other does not require action until 2010.A purchase commitment is a contract between two parties, requiring one of the parties to purchase a specified amount of inventory at a set price, on or before a particular date. Read through the example of the two purchase commitments entered into by Matrix in July of 2009. We will look at the accounting for both of these purchase commitments. It is important to note that one of the purchase commitments requires action during 2009, while the other does not require action until 2010.

    16. Purchase Commitments Part I Let’s look at the single-period purchase commitment first. On the date of acquisition, the inventory items had a market price of $425,000, so Lassiter will debit inventory for $425,000, debit the loss on purchase commitment for $75,000, and credit accounts payable for $500,000. Had the market price of the inventory been $500,000 on the date of acquisition, the company would not experience a loss. The account payable was paid on December 15, 2011, so Lassiter would make the usual entry to debit accounts payable and credit cash for the commitment price of $500,000. Part II For the multi-period purchase commitment, Lassiter did not acquire the inventory until 2012, so at the end of 2011, the company would determine the market price of the inventory items and, in our case, debit estimated loss on purchase commitment and credit estimated liability on purchase commitment for $60,000 ($600,000 commitment price less $540,000 market price). On February 15, 2012, Lassiter purchase the inventory paying cash. The market price of the inventory at the time of acquisition was $510,000. Lassiter will prepare a somewhat complex journal entry to debit inventory for $510,000, debit loss on purchase commitment ($540,000 previous market price less $510,000 current market price), debit the estimated liability on purchase commitment for $60,000, and credit cash for the commitment price of $600,000.Part I Let’s look at the single-period purchase commitment first. On the date of acquisition, the inventory items had a market price of $425,000, so Lassiter will debit inventory for $425,000, debit the loss on purchase commitment for $75,000, and credit accounts payable for $500,000. Had the market price of the inventory been $500,000 on the date of acquisition, the company would not experience a loss. The account payable was paid on December 15, 2011, so Lassiter would make the usual entry to debit accounts payable and credit cash for the commitment price of $500,000. Part II For the multi-period purchase commitment, Lassiter did not acquire the inventory until 2012, so at the end of 2011, the company would determine the market price of the inventory items and, in our case, debit estimated loss on purchase commitment and credit estimated liability on purchase commitment for $60,000 ($600,000 commitment price less $540,000 market price). On February 15, 2012, Lassiter purchase the inventory paying cash. The market price of the inventory at the time of acquisition was $510,000. Lassiter will prepare a somewhat complex journal entry to debit inventory for $510,000, debit loss on purchase commitment ($540,000 previous market price less $510,000 current market price), debit the estimated liability on purchase commitment for $60,000, and credit cash for the commitment price of $600,000.

    17. Inventory Disclosures (CVS from MD&A) Inventory Our inventory is stated at the lower of cost or market on a first-in, first-out basis using the retail method of accounting to determine cost of sales and inventory in our CVS/pharmacy stores, weighted average cost to determine cost of sales and inventory in our mail service and specialty pharmacies and the cost method of accounting on a first-in, first-out basis to determine inventory in our distribution centers. Under the retail method, inventory is stated at cost, which is determined by applying a cost-to-retail ratio to the ending retail value of our inventory. Since the retail value of our inventory is adjusted on a regular basis to reflect current market conditions, our carrying value should approximate the lower of cost or market. In addition, we reduce the value of our ending inventory for estimated inventory losses that have occurred during the interim period between physical inventory counts.

    18. Inventory Disclosures (Walmart from MD&A) Inventories The Company values inventories at the lower of cost or market as determined primarily by the retail method of accounting, using the last-in, first-out (“LIFO”) method for substantially all of the Walmart U.S. segment’s merchandise inventories. The retail method of accounting results in inventory being valued at the lower of cost or market since permanent markdowns are currently taken as a reduction of the retail value of inventory. The Sam’s Club segment’s merchandise is valued based on the weighted-average cost using the LIFO method. Inventories for the Walmart International operations are primarily valued by the retail method of accounting and are stated using the first-in, first-out (“FIFO”) method. At January 31, 2011 and 2010, our inventories valued at LIFO approximated those inventories as if they were valued at FIFO.

    19. Inventory Disclosures (Walmart from MD&A) Inventories (Continued) Under the retail method, inventory is stated at cost, which is determined by applying a cost-to-retail ratio to each merchandise grouping’s retail value. The FIFO cost-to-retail ratio is based on the initial margin of beginning inventory plus the fiscal year purchase activity. The cost-to-retail ratio for measuring any LIFO reserves is based on the initial margin of the fiscal year purchase activity less the impact of any markdowns. The retail method requires management to make certain judgments and estimates that may significantly impact the ending inventory valuation at cost, as well as the amount of gross profit recognized. Judgments made include recording markdowns used to sell through inventory and shrinkage. When management determines the salability of inventory has diminished, markdowns for clearance activity and the related cost impact are recorded at the time the price change decision is made. Factors considered in the determination of markdowns include current and anticipated demand, customer preferences and age of merchandise, as well as seasonal and fashion trends. Changes in weather patterns and customer preferences related to fashion trends could cause material changes in the amount and timing of markdowns from year to year.

    20. LIFO to FIFO Conversion – Dow Chemical

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