Inventory Flashcards
(3 cards)
If beginning inventory is understated, the so will goods available for sale and COGS also.
If ending inventory is overstated, then too much is taken out in computing COGS, and again COGS will be understated.
Garcel, Inc. held unfinished inventory at a cost of $85,000 with a sales value of $125,000. The inventory will cost $10,500 to complete. The normal profit margin is 30% of sales. The replacement cost of the inventory was $75,000. What amount should Garcel report (accounted for under the LIFO method) as inventory on balance sheet?
A departure from the cost basis is required when the utility of goods is no longer as great as cost; for inventory, the loss should be recognized in the period in which the decline takes place. Inventory measured using any method other than LIFO or the retail inventory method (e.g., FIFO or average cost) is measured at the lower of cost and net realizable value (NRV), which is defined to be the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. If the NRV of inventory is lower than its cost, the difference is recognized as a loss in earnings in the period in which it occurs.
In this case, market value will be the replacement cost unless replacement cost exceeds net realizable value (NRV) (estimated selling price less costs of completion and disposal), in which case market will be net realizable value (the ceiling); OR replacement cost is less than net realizable value reduced by a normal profit margin (the floor), in which case market will be the floor.
NRV (ceiling) $125,000 – $10,500 = $114,500
Replacement cost = $ 75,000
NRV - Normal profit (floor) $114,500 – (30% × $125,000) = $ 77,000
Garcel should report inventory at $77,000, the lower of cost or market. (Note: market cannot be less than the floor value of $77,000.)
Dean Company uses the retail inventory method to estimate its inventory for interim statement purposes. Data relating to the computation of the inventory at July 31 are as follows:
Cost Retail Inventory, 2/1 $ 180,000 $ 250,000 Purchases 1,020,000 1,575,000 Markups, net 175,000 Sales 1,705,000 Estimated normal shoplifting losses 20,000 Markdowns net 125,000 Under the approximate lower of average cost or market retail method, Dean’s estimated inventory at July 31 is:
First, add the beginning inventory and purchases in the cost column:
$180,000 + $1,020,000 = $1,200,000
When seeking the lower of cost or market method for the retail method, add, in the retail column, first only the beginning inventory, the purchases, and the net markups:
$250,000 + $1,575,000 + $175,000 = $2,000,000
Divide these subtotals, to get the cost-to-retail ratio:
$1,200,000 ÷ $2,000,000 = 0.6
Next, from the subtotal in the retail column, subtract the sales, normal losses, and markdowns, leaving an ending inventory, at retail, of $150,000:
$2,000,000 – $1,705,000 – $20,000 – $125,000 = $150,000
The final step to get the ending inventory at lower of average cost or market is to take the ending inventory at retail of $150,000 and multiply it by the cost to retail ratio of 0.6:
$150,000 × 0.6 = $90,000
Note: Inventory measured using any method other than LIFO or the retail inventory method (e.g., FIFO or average cost) is measured at the lower of cost and net realizable value (NRV), which is defined to be the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. If the NRV of inventory is lower than its cost, the difference is recognized as a loss in earnings in the period in which it occurs.
