Chapter 9 Inventories: Additional Valuation Issues This slide deck contains animations. Please disable animations if they cause issues with your device.
Learning Objectives After studying this chapter, you should be able to: 1. Describe and apply the lower-of-cost-or-net realizable value rule. 2. Describe and apply the lower-of-cost-or-market rule. 3. Identify other inventory valuation issues. 4. Determine ending inventory by applying the gross profit method. 5. Determine ending inventory by applying the retail inventory method.
Assume that Mander Corp. has unfinished inventory with a cost of $950, a sales value of $1,000, estimated cost of completion of $50, and estimated selling costs of $200. Mander’s net realizable value is computed as follows.
Definition of Net Realizable Value LCNRV Disclosures
• Mander reports inventory at $750 • In its income statement, Mander reports a Loss Due to Decline of Inventory to N R V of $200 ($950 − $750) Kesa Electricals Inventories are stated at the lower-of-cost-or-net realizable value. Cost is determined using the weighted average method. Net realisable value represents the estimated selling price in the ordinary course of business, less applicable variable selling expenses. LO 1
Instead of crediting the Inventory account for market adjustments, companies generally use an allowance account, often referred to as Allowance to Reduce Inventory to NRV. Loss Due to Decline of Inventory to NRV Allowance to Reduce Inventory to NRV
Presentation of Inventory Using an Allowance Account Inventory (at cost) Allowance to reduce inventory to NRV Inventory (at NRV)
Use of an Allowance—Multiple Periods In general, accountants adjust the allowance account balance at the next year-end to agree with the discrepancy between cost and the LCNRV at that balance sheet date. Date Dec. 31, 2016 Dec. 31, 2017 Dec. 31, 2018 Dec. 31, 2019
Inventory Inventory at at Cost NRV $188,000 $176,000 194,000 187,000 173,000 174,000 182,000 180,000
Amount Adjustment Required in of Valuation Valuation Account Effect on Net Account Balance Income $12,000 $12,000 inc. Decrease 7,000 5,000 dec. Increase 0 7,000 dec. Increase 2,000 2,000 inc. Decrease
Lower-of-Cost-or-Market (1 of 6) The use of the lower-of-cost-or-net realizable value method works well to measure the decline in value of a company’s inventory for most companies. FASB granted an exception to the LCNRV approach for companies that use the LIFO or retail inventory methods. • Rather than comparing cost to net realizable value companies compare a “designated market value” of inventory to cost • Approach is commonly referred to as lower-of-cost-ormarket (LCM) LO 2
This approach begins with replacement cost, then applies two additional limitations to value ending inventory. • Net realizable value (ceiling) • Net realizable value less a normal profit margin (floor)
Lower-of-Cost-or-Market Net Realizable Value (NRV)
NRV is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion and disposal. 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.
Assume that Parker Corp. has unfinished inventory with a sales value of $1,000, estimated cost of completion and disposal of $300, and a normal profit margin of 10 percent of sales. Parker determines the following net realizable value. Inventory—sales value Less: Estimated cost of completion and disposal Net realizable value Less: Allowance for normal profit margin (10% of sales) Net realizable value less a normal profit margin LO 2
What is the rationale for the Ceiling and Floor limitations? • Ceiling – prevents overstatement of the value of obsolete, damaged, or shopworn inventories • Floor – deters understatement of inventory and overstatement of loss in current period