INVENTORIES

Tujuan Pembelajaran

1. Membandingkan cost flow assumptions untuk perhitungan nilai persediaan.

2. Menerapkan konsep perhitungan lower-of-cost-or-net realizable value.
3. Menerapkan perlakuan akuntansi untuk aset biologis, purchase commitment dan pembelian
lumpsum.
4. Menentukan nilai persediaan akhir dengan mengunakan gross profit method.
5. Menentukan nilai persediaan akhir dengan mengunakan conventional retail method.

LO1: Membandingkan cost flow assumptions untuk perhitungan nilai persediaan.

During any given fiscal period, companies typically purchase merchandise at several different prices.
If a company prices inventories at cost and it made numerous purchases at different unit costs,
which cost should it use? Conceptually, a specific identification of the given items sold and unsold
seems optimal.

Therefore, the IASB requires use of the specific identification method in cases where inventories are
not ordinarily interchangeable or for goods and services produced or segregated for specific
projects. For example, an inventory of single-family homes is a good candidate for use of the specific
identification method.

Unfortunately, for most companies, the specific identification method is not practicable. Only in
situations where inventory turnover is low, unit price is high, or inventory quantities are small are
the specific identification criteria met. In other cases, the cost of inventory should be measured
using one of two cost flow assumptions: (1) first-in, first-out (FIFO) or (2) average-cost.

To illustrate these cost flow methods, assume that Call-Mart SpA had the following transactions in its
first month of operations.

From this information, Call-Mart computes the ending inventory of 6,000 units and the cost of goods
available for sale (beginning inventory + purchases) of €43,900 [(2,000 @ €4.00) + (6,000 @ €4.40) +
(2,000 @ €4.75)].

The question is, which price or prices should it assign to the 6,000 units of ending inventory? The
answer depends on which cost flow assumption it uses.

Specific Identification

Specific identification calls for identifying each item sold and each item in inventory. A company
includes in cost of goods sold the costs of the specific items sold. It includes in inventory the costs of
the specific items on hand. This method may be used only in instances where it is practical to
separate physically the different purchases made. As a result, most companies only use this method
when handling a relatively small number of costly, easily distinguishable items. In the retail trade,
this includes some types of jewelry, fur coats, automobiles, and some furniture. In manufacturing, it
includes special orders and many products manufactured under a job cost system.

To illustrate, assume that Call-Mart's 6,000 units of inventory consists of 1,000 units from the March
2 purchase, 3,000 from the March 15 purchase, and 2,000 from the March 30 purchase. Illustration
8.7 shows how Call-Mart computes the ending inventory and cost of goods sold.

Specific identification matches actual costs against actual revenue. Thus, a company reports ending
inventory at actual cost. In other words, under specific identification the cost flow matches the
physical flow of the goods. On closer observation, however, this method has certain deficiencies
inaddition to its lack of practicability in many situations.

Average-Cost

As the name implies, the average-cost method prices items in the inventory on the basis of the
average cost of all similar goods available during the period.

To illustrate use of the periodic inventory method (amount of inventory computed at the end of the
period), Call-Mart computes the ending inventory and cost of goods sold using a weighted-average
method as shown in Illustration 8.8.

In computing the average cost per unit, Call-Mart includes the beginning inventory, if any, both in
the total units available and in the total cost of goods available.
Companies use the moving-average method with perpetual inventory records.

Illustration 8.9 shows the application of the average-cost method for perpetual records.

In this method, Call-Mart computes a new average unit cost each time it makes a purchase. For
example, on March 15, after purchasing 6,000 units for €26,400, CallMart has 8,000 units costing
€34,400 (€8,000 plus €26,400) on hand. The average unit cost is €34,400 divided by 8,000, or €4.30.

Call-Mart uses this unit cost in costing withdrawals until it makes another purchase. At that point,
Call-Mart computes a new average unit cost. Accordingly, the company shows the cost of the 4,000
units withdrawn on March 19 at €4.30, for a total cost of goods sold of €17,200. On March 30,
following the purchase of 2,000 units for €9,500, Call-Mart determines a new unit cost of €4.45, for
an ending inventory of €26,700.

Companies often use average-cost methods for practical rather than conceptual reasons. These
methods are simple to apply and objective. They are not as subject to income manipulation as some
of the other inventory pricing methods. In addition, proponents of the average-cost methods reason
that measuring a specific physical flow of inventory is often impossible. Therefore, it is better to cost
items on an average-price basis.

First-In, First-Out (FIFO)

The first-in, first-out (FIFO) method assumes that a company uses goods in the order in which it
purchases them. In other words, the FIFO method assumes that the first goods purchased are the
first used (in a manufacturing concern) or the first sold (in a merchandising concern). The inventory
remaining must therefore represent the most recent purchases.

To illustrate, assume that Call-Mart uses the periodic inventory system. It determines its cost of the
ending inventory by taking the cost of the most recent purchase and working back until it accounts
for all units in the inventory. Call-Mart determines its ending inventory and cost of goods sold as
shown in Illustration 8.10.
If Call-Mart instead uses a perpetual inventory system in quantities and euros, it attaches a cost
figure to each withdrawal. Then, the cost of the 4,000 units removed on March 19 consists of the
cost of the items purchased on March 2 and March 15.

Illustration 8.11 shows the inventory on a FIFO basis perpetual system for Call-Mart.

Notice that in these two FIFO examples, the cost of goods sold (€16,800) and ending inventory
(€27,100) are the same. In all cases where FIFO is used, the inventory and cost of goods sold would
be the same at the end of the month whether a perpetual or periodic system is used. Why? Because
the same costs will always be first in and, therefore, first out. This is true whether a company
computes cost of goods sold as it sells goods throughout the accounting period (the perpetual
system) or as a residual at the end of the accounting period (the periodic system).

One objective of FIFO is to approximate the physical flow of goods. At the same time, it prevents
manipulation of income. With FIFO, a company cannot pick a certain cost item to charge to expense.

Another advantage of the FIFO method is that the ending inventory is close to current cost. Because
the first goods in are the first goods out, the ending inventory amount consists of the most recent
purchases.

However, the FIFO method fails to match current costs against current revenues on the income
statement. A company charges the oldest costs against the more current revenue, possibly distorting
gross profit and net income.

LO2: Menerapkan konsep perhitungan lower-of-cost-or-net realizable value.

Lower-of-Cost-or-Net Realizable Value (LCNRV)

Inventories are recorded at their cost. However, if inventory declines in value below its original cost,
a major departure from the historical cost principle occurs. Whatever the reason for a decline—
obsolescence, price-level changes, or damaged goods—a company should write down the inventory
to net realizable value to report this loss. A company abandons the historical cost principle when the
future utility (revenueproducing ability) of the asset drops below its original cost.

Net Realizable Value

Recall that cost is the acquisition price of inventory computed using one of the historical cost-based
methods—specific identification, average-cost, or FIFO. The term net realizable value (NRV) refers to
the net amount that a company expects to realize from the sale of inventory. Specifically, net
realizable value is the estimated selling price in the normal course of business less estimated costs to
complete and estimated costs to make a sale.

To illustrate, assume that Mander AG 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 shown in Illustration 9.1.

Mander reports inventory on its statement of financial position at €750. In its income statement,
Mander reports a Loss on Inventory Write-Down of €200 (€950 − €750). A departure from cost is
justified because inventories should not be reported at amounts higher than their expected
realization from sale or use. In addition, a company like Mander should charge the loss of utility
against revenues in the period in which the loss occurs, not in the period of sale.

Illustration of LCNRV

As indicated, a company values inventory at LCNRV. A company estimates net realizable value based
on the most reliable evidence of the inventories' realizable amounts (expected selling price,
expected costs of completion, and expected costs to sell).

To illustrate, Jinn-Feng Foods computes its inventory at LCNRV, as shown in Illustration 9.3 (amounts
in thousands).
As indicated, the final inventory value of ¥384,000 equals the sum of the LCNRV for each of the
inventory items. That is, Jinn-Feng applies the LCNRV rule to each individual type of food.

Methods of Applying LCNRV

In the Jinn-Feng Foods illustration, we assumed that the company applied the LCNRV rule to each
individual type of food. However, companies may apply the LCNRV rule to a group of similar or
related items, or to the total of the inventory.

To illustrate, assume that Jinn-Feng Foods separates its food products into two major groups, frozen
and canned, as shown in Illustration 9.4.
If Jinn-Feng applied the LCNRV rule to individual items, the amount of inventory is ¥384,000. If
applying the rule to major groups, it jumps to ¥394,000. If applying LCNRV to the total inventory, it
totals ¥415,000. Why this difference? When a company uses a major group or total-inventory
approach, net realizable values higher than cost offset net realizable values lower than cost. For Jinn-
Feng, using the similar or- related-items approach partially offsets the high net realizable value for
spinach. Using the total-inventory approach totally offsets it.

Recording Net Realizable Value Instead of Cost

One of two methods may be used to record the income effect of valuing inventory at net realizable
value. One method, referred to as the cost-of-goods-sold method, debits cost of goods sold for the
write-down of the inventory to net realizable value. As a result, the company does not report a loss
in the income statement because the cost of goods sold already includes the amount of the loss.

The second method, referred to as the loss method, debits a loss account for the writedown of the
inventory to net realizable value. We use the following inventory data for Ricardo SpA to illustrate
entries under both methods.

Illustration 9.5 shows the entries for both the cost-of-goods-sold and loss methods, assuming the
use of a perpetual inventory system.

The cost-of-goods-sold method buries the loss in the Cost of Goods Sold account. The loss method,
by identifying the loss due to the write-down, shows the loss separate from Cost of Goods Sold in
the income statement.

Illustration 9.6 contrasts the differing amounts reported in the income statement under the two
approaches, using data from the Ricardo example.
Use of an Allowance

Instead of crediting the Inventory account for net realizable value adjustments, companies generally
use an allowance account, often referred to as Allowance to Reduce Inventory to Net Realizable
Value.

For example, using an allowance account under the loss method, Ricardo SpA makes the following
entry to record the inventory write-down to net realizable value.

Loss Due to Decline of Inventory to Net Realizable Value 12,000

Allowance to Reduce Inventory to Net Realizable Value 12,000

Use of the allowance account results in reporting both the cost and the net realizable value of the
inventory. Ricardo reports inventory in the statement of financial position as shown in Illustration
9.7.

The use of the allowance under the cost-of-goods-sold or loss method permits both the income
statement and the statement of financial position to reflect inventory measured at €82,000,
although the statement of financial position shows a net amount of €70,000.

Recovery of Inventory Loss

In periods following the write-down, economic conditions may change such that the net realizable
value of inventories previously written down may be greater than cost or there is clear evidence of
an increase in the net realizable value. In this situation, the amount of the write-down is reversed,
with the reversal limited to the amount of the original write-down.
Continuing the Ricardo example, assume that in the subsequent period, market conditions change,
such that the net realizable value increases to €74,000 (an increase of €4,000). As a result, only
€8,000 is needed in the allowance. Ricardo makes the following entry, using the loss method.

Allowance to Reduce Inventory to Net Realizable Value 4,000

Recovery of Inventory Loss (€74,000 − €70,000) 4,000

LO3: Menerapkan perlakuan akuntansi untuk aset biologis, purchase commitment dan pembelian
lumpsum.

Valuation Bases

Net Realizable Value

Two common situations in which net realizable value is the general rule for valuing inventory:

1. Agricultural assets (including biological assets and agricultural produce).

2. Commodities held by broker-traders.

Agricultural Inventory

Under IFRS, net realizable value measurement is used for inventory when the inventory is related to
agricultural activity. In general, agricultural activity results in two types of agricultural assets: (1)
biological assets or (2) agricultural produce at the point of harvest.

A biological asset (classified as a non-current asset) is a living animal or plant, such as sheep, cows,
fruit trees, or cotton plants. Agricultural produceagricultural produce is the harvested product of a
biological asset, such as wool from a sheep, milk from a dairy cow, picked fruit from a fruit tree, or
cotton from a cotton plant.

The accounting for these assets is as follows.

 Biological assets are measured on initial recognition and at the end of each reporting period
at fair value less costs to sell (net realizable value). Companies record a gain or loss due to
changes in the net realizable value of biological assets in income when it arises.
 Agricultural produce (which are harvested from biological assets) are measured at fair value
less costs to sell (net realizable value) at the point of harvest. Once harvested, the net
realizable value of the agricultural produce becomes its cost, and this asset is accounted for
similar to other inventories held for sale in the normal course of business.

Illustration of Agricultural Accounting at Net Realizable Value

To illustrate the accounting at net realizable value for agricultural assets, assume that Bancroft Dairy
produces milk for sale to local cheese-makers. Bancroft began operations on January 1, 2019, by
purchasing 420 milking cows for €460,000.

Illustration 9.9 presents Bancroft's information related to the milking cows.

* The carrying value is measured at fair value less costs to sell (net realizable value). The fair value of
milking cows is determined based on market prices of livestock of similar age, breed, and genetic
merit.

** Milk is initially measured at its fair value less costs to sell (net realizable value) at the time of
milking. The fair value of milk is determined based on market prices in the local area.

As indicated, the carrying value of the milking cows increased during the month. Part of the change
is due to changes in market prices (less costs to sell) for milking cows. The change in market price
may also be affected by growth—the increase in value as the cows mature and develop increased
milking capacity. At the same time, as mature cows are milked, their milking capacity declines (fair
value decrease due to harvest).

Bancroft makes the following entry to record the change in carrying value of themilking cows.

Biological Asset (milking cows) (€493,800 − €460,000) 33,800

Unrealized Holding Gain or Loss—Income 33,800

As a result of this entry, Bancroft's statement of financial position reports Biological Asset (milking
cows) as a non-current asset at fair value less costs to sell (net realizable value). In addition, the
unrealized gains and losses are reported as “Other income and expense” on the income statement.

In subsequent periods at each reporting date, Bancroft continues to report Biological Asset at net
realizable value and records any related unrealized gains or losses in income. Because there is a
ready market for the biological assets (milking cows), valuation at net realizable value provides more
relevant information about these assets.

In addition to recording the change in the biological asset, Bancroft makes the following summary
entry to record the milk harvested for the month of January.

Inventory (milk) 36,000

Unrealized Holding Gain or Loss—Income 36,000

The milk inventory is recorded at net realizable value at the time it is harvested and Unrealized
Holding Gain or Loss—Income is recognized in income. As with the biological assets, net realizable
value is considered the most relevant for purposes of valuation at harvest.

What happens to the milk inventory that Bancroft recorded upon harvesting the milk from the cows?
Assuming the milk harvested in January was sold to a local cheese-maker for €38,500, Bancroft
records the sale as follows.
Cash 38,500

Cost of Goods Sold 36,000

Inventory (milk) 36,000

Sales Revenue 38,500

Thus, once harvested, the net realizable value of the harvested milk becomes its cost, and the milk is
accounted for similar to other inventories held for sale in the normal course of business.

A final note: Some animals or plants may not be considered biological assets but would be classified
and accounted for as other types of assets (not at net realizable value). For example, a pet shop may
hold an inventory of dogs purchased from breeders that it then sells. Because the pet shop is not
breeding the dogs, these dogs are not considered biological assets. As a result, the dogs are
accounted for as inventory held for sale (at LCNRV).

Commodity Broker-Traders

Commodity broker-traders also generally measure their inventories at fair value less costs to sell (net
realizable value), with changes in net realizable value recognized in income in the period of the
change. Broker-traders buy or sell commodities (such as harvested corn, wheat, precious metals,
heating oil) for others or on their own account. The primary purpose for holding these inventories is
to sell the commodities in the near term and generate a profit from fluctuations in price. Thus, net
realizable value is the most relevant measure in this industry because it indicates the amount that
the broker-trader will receive from this inventory in the future.

Relative Standalone Sales Value

A special problem arises when a company buys a group of varying units in a single lump-sum (basket)
purchase, also called a basket purchase.

To illustrate, assume that Woodland Developers purchases land for $1 million that it will subdivide
into 400 lots. These lots are of different sizes and shapes but can be roughly sorted into three groups
graded A, B, and C. As Woodland sells the lots, it apportions the purchase cost of $1 million among
the lots sold and the lots remainingon hand.

Why would Woodland not simply divide the total cost of $1 million by 400 lots, to get a cost of
$2,500 for each lot? This approach would not recognize that the lots vary in size, shape, and
attractiveness. Therefore, to accurately value each unit, the common and most logical practice is to
allocate the total among the various units on the basis of their relative standalone sales value.

Illustration 9.10 shows the allocation of relative standalone sales value for the Woodland Developers
example.
Using the amounts given in the “Cost per Lot” column, Woodland can determine the cost of lots sold
and the gross profit as shown in Illustration 9.11.

The ending inventory is therefore $320,000 ($1,000,000 − $680,000). Woodland also can compute
this inventory amount another way. The ratio of cost to selling price for all the lots is $1 million
divided by $2,500,000, or 40 percent.

Accordingly, if the total sales price of lots sold is, say $1,700,000, then the cost of the lots sold is 40
percent of $1,700,000, or $680,000. The inventory of lots on hand is then $1 million less $680,000,
or $320,000.

The petroleum industry widely uses the relative standalone sales value method to value (at cost) the
many products and by-products obtained from a barrel of crude oil.

Purchase Commitments—A Special Problem

In many lines of business, a company's survival and continued profitability depend on its having a
sufficient stock of merchandise to meet customer demand. Consequently, it is quite common for a
company to make purchase commitments, which are agreements to buy inventory weeks, months,
or even years in advance. Generally, the seller retains title to the merchandise or materials covered
in the purchase commitments. Indeed, the goods may exist only as natural resources as unplanted
seed (in the case of agricultural commodities), or as work in process (in the case of a product).

Usually, it is neither necessary nor proper for the buyer to make any entries to reflect commitments
for purchases of goods that the seller has not shipped. Ordinary orders, for which the buyer and
seller will determine prices at the time of shipment and which are subject to cancellation, do not
represent either an asset or a liability to the buyer. Therefore, the buyer need not record such
purchase commitments or report them in the financial statements.
To illustrate the accounting problem, assume that Apres Paper AG signed timbercutting contracts
with Galling Land Ltd. to be executed in 2020 at a price of €10,000,000. Assume further that the
market price of the timber-cutting rights on December 31, 2019, dropped to €7,000,000.

Apres would make the following entry on December 31, 2019.

Unrealized Holding Gain or Loss—Income 3,000,000

Purchase Commitment Liability (€10,000,000 − €7,000,000) 3,000,000

Apres reports this unrealized holding loss in the income statement under “Other income and
expense.” And because the contract is to be executed within the next fiscal year, Apres reports the
Purchase Commitment Liability (often referred to as a provision) in the current liabilities section on
the statement of financial position.

When Apres cuts the timber at a cost of €10 million, it would make the following entry.

Purchases (Inventory) 7,000,000

Purchase Commitment Liability 3,000,000

Cash 10,000,000

The result of the purchase commitment was that Apres paid €10 million for a contract worth only €7
million. It recorded the loss in the previous period—when the price actually declined.

If Apres can partially or fully recover the contract price before it cuts the timber, it reduces the
Purchase Commitment Liability. In that case, it then reports in the period of the price increase a
resulting gain for the amount of the partial or full recovery.

LO5: Menentukan nilai persediaan akhir dengan mengunakan gross profit method.

The Gross Profit Method of Estimating Inventory

One substitute method of verifying or determining the inventory amount is the gross profit method
(also called the gross margin method). Auditors widely use this method in situations where they
need only an estimate of the company's inventory (e.g., interim reports). Companies also use this
method when fire or other catastrophe destroys either inventory or inventory records.

The gross profit method relies on three assumptions:

1. The beginning inventory plus purchases equal total goods to be accounted for.
2. Goods not sold must be on hand.
3. The sales, reduced to cost, deducted from the sum of the opening inventory plus purchases,
equal ending inventory.

To illustrate, assume that Cetus SE has a beginning inventory of €60,000 and purchases of €200,000,
both at cost. Sales at selling price amount to €280,000. The gross profit on selling price is 30 percent.
Cetus applies the gross profit method as shown in Illustration 9.13.
The current period's records contain all the information Cetus needs to compute inventory at cost,
except for the gross profit percentage. Cetus determines the gross profit percentage by reviewing
company policies or prior period records. In some cases, companies must adjust this percentage if
they consider prior periods unrepresentative of the current period.

Computation of Gross Profit Percentage

In most situations, the gross profit percentage is stated as a percentage of selling price. The previous
illustration, for example, used a 30 percent gross profit on sales. Gross profit on selling price is the
common method for quoting the profit for severalreasons.

To see how to compute a gross profit percentage, assume that an article costs €15 and sells for €20,
a gross profit of €5. As shown in the computations in Illustration 9.14, this markup is 14 or 25
percent of retail, and 13 or 33,13 percent of cost.

ILLUSTRATION 9.14 Computation of Gross Profit Percentage

Markup Retail = €5/€20 = 25% at retail

Markup Cost = €5/€15 = 33,12% on cost

Although companies normally compute the gross profit on the basis of selling price, you should
understand the basic relationship between markup on cost and markup on selling price.

For example, assume that a company marks up a given item by 25 percent on cost. What, then, is
the gross profit on selling price? To find the answer, assume that the item sells for €1. In this case,
the following formula applies.

Cost + Gross profit = Selling price

C + 0.25C = SP
(1+.25)C =SP
1.25C =€1.00
C = €0.80
The gross profit equals €0.20 (€1.00 − €0.80). The rate of gross profit on selling price is therefore 20
percent (€0.20/€1.00).

Conversely, assume that the gross profit on selling price is 20 percent. What is the markup on cost?
To find the answer, assume that the item sells for €1. Again, the same formula holds:

Cost + Gross profit = Selling price

C+.20SP = SP
C = (1−.20)SP
C= 0.80SP
C= 0.80(€1.00)
C = €0.80
As in the previous example, the markup equals €0.20 (€1.00 − €0.80). The markup on cost is 25
percent (€0.20/€0.80).

Evaluation of Gross Profit Method

What are the major disadvantages of the gross profit method? One disadvantage is that it provides
an estimate. As a result, companies must take a physical inventory once a year to verify the
inventory. Second, the gross profit method uses past percentages in determining the markup.
Although the past often provides answers to the future, a current rate is more appropriate. Note
that whenever significant fluctuations occur, companies should adjust the percentage as
appropriate. Third, companies must be careful in applying a blanket gross profit rate. Frequently, a
store or department handles merchandise with widely varying rates of gross profit. In these
situations, the company may need to apply the gross profit method by subsections, lines of
merchandise, or a similar basis that classifies merchandise according to their respective rates of
gross profit.

LO5: Menentukan nilai persediaan akhir dengan mengunakan conventional retail method.

Retail Inventory Method

Retailers with certain types of inventory may use the specific identification method to value their
inventories. Such an approach makes sense when a retailer holds significant individual inventory
units, such as automobiles, pianos, or fur coats. However, imagine attempting to use such an
approach at high-volume retailers and supermarkets that have many different types of merchandise.
It would be extremely difficult to determine the cost of each sale, to enter cost codes on the tickets,
to change the codes to reflect declines in value of the merchandise, to allocate costs such as
transportation, and so on.

An alternative is to compile the inventories at retail prices. For most retailers, an observable pattern
between cost and price exists. The retailer can then use a formula to convert retail prices to cost.
This method is called the retail inventory method. It requires that the retailer keep a record of (1)
the total cost and retail value of goods purchased, (2) the total cost and retail value of the goods
available for sale, and (3) the sales for the period.

Illustration 9.17 shows the retail inventory method calculations.

Retail Inventory Method with Markups and Markdowns—Conventional Method

Retailers use markup and markdown concepts in developing the proper inventory valuation at the
end of the accounting period. To obtain the appropriate inventory figures, companies must give
proper treatment to markups, markup cancellations, markdowns, and markdown cancellations.

To illustrate the different possibilities, consider the data for In-Fusion SA shown in Illustration 9.18.
In-Fusion can calculate its ending inventory at cost under two assumptions, A and B.

Assumption A: Computes a cost ratio after markups (and markup cancellations) but before
markdowns.

Assumption B: Computes a cost ratio after both markups and markdowns (and cancellations).
The question becomes: Which assumption and which percentage should In-Fusion use to compute
the ending inventory valuation? The answer depends on which retail inventory method In-Fusion
chooses.

One approach uses only Assumption A (a cost ratio using markups but not markdowns). It
approximates the lower-of-average-cost-or-net realizable value. We will refer to this approach as the
conventional retail inventory method or the LCNRV.