1 Accounting for Inventories

L E A R N IN G O B J E C T IV E S

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Identify major classifications of 5. Describe and compare the methods used to price
inventories.
inventory.
6. Describe and apply the lower-of-cost-or-net realizable
2. Distinguish between perpetual and value rule.
periodic inventory systems.
7. Explain when companies value inventories at net
3. Determine the goods included in realizable value.
inventory and the effects of inventory 8. Determine ending inventory by applying the gross
errors on the financial statements. profit method.
4. Understand the items to include as 9. Determine ending inventory by applying the retail
inventory cost. inventory method.
INVENTORY ISSUES

Classification
Inventories are assets:
 items held for sale in the ordinary course of business, or
 goods to be used in the production of goods to be sold.

Businesses with Inventory

Merchandising or Manufacturing
Company Company
INVENTORY ISSUES

Classification
 One inventory
account.
 Purchase
merchandise in
a form ready
for sale.
INVENTORY ISSUES

Classification
Three accounts
 Raw Materials
 Work in Process
 Finished Goods
INVENTORY ISSUES Flow of Costs through
Manufacturing and
Merchandising
Companies

Classification
INVENTORY ISSUES

Inventory Cost Flow

Two types of systems for maintaining inventory records — perpetual

system or periodic system.
Inventory Cost Flow

Perpetual System
1. Purchases of merchandise are debited to Inventory.

2. Freight-in is debited to Inventory. Purchase returns and

allowances and purchase discounts are credited to Inventory.

3. Cost of goods sold is debited and Inventory is credited for

each sale.

4. Subsidiary records show quantity and cost of each type of

inventory on hand.

The perpetual inventory system provides a

continuous record of the balance in both the
Inventory and Cost of Goods Sold accounts.
Inventory Cost Flow

Periodic System
1. Purchases of merchandise are debited to Purchases.

2. Ending Inventory determined by physical count.

3. Calculation of Cost of Goods Sold:

Beginning inventory $ 100,000

Purchases, net + 800,000
Goods available for sale 900,000
Ending inventory - 125,000
Cost of goods sold $ 775,000
Inventory Cost Flow

Comparing Perpetual and Periodic Systems

Illustration: Fesmire Company had the following transactions
during the current year.

Record these transactions using the Perpetual and Periodic

systems.
Inventory Cost Flow Comparative Entries—
Perpetual vs. Periodic
Inventory Cost Flow

Illustration: Assume that at the end of the reporting period, the

perpetual inventory account reported an inventory balance of
$4,000. However, a physical count indicates inventory of $3,800 is
actually on hand. The entry to record the necessary write-down is
as follows.

Inventory Over and Short 200

Inventory 200

Note: Inventory Over and Short adjusts Cost of Goods Sold. In

practice, companies sometimes report Inventory Over and Short in the
“Other income and expense” section of the income statement.
INVENTORY ISSUES

Inventory Control
All companies need periodic verification of the inventory records
 by actual count, weight, or measurement, with
 counts compared with detailed inventory records.

Companies should take the physical inventory

 near the end of their fiscal year,
 to properly report inventory quantities in their annual
accounting reports.
 INVENTORY ISSUES

Basic Issues in Inventory Valuation

Companies must allocate the cost of all the goods available for
sale (or use) between the goods that were sold or used and
those that are still on hand.

Computation of Cost
of Goods Sold
Basic Issues in Inventory Valuation

Valuing inventories requires determining

1. The physical goods to include in inventory (who owns
the goods?—goods in transit, consigned goods, special
sales agreements).

2. The costs to include in inventory (product vs. period

costs).

3. The cost flow assumption to adopt (specific

identification, average-cost, FIFO, retail, etc.).
PHYSICAL GOODS INCLUDED IN
INVENTORY

A company should record inventory when it obtains legal title

to the goods.

Guidelines for Determining Ownership

GOODS INCLUDED IN INVENTORY

Goods in Transit
Example: LG (KOR) determines ownership by applying the
“passage of title” rule.
 If a supplier ships goods to LG f.o.b. shipping point, title
passes to LG when the supplier delivers the goods to the
common carrier, who acts as an agent for LG.
 If the supplier ships the goods f.o.b. destination, title
passes to LG only when it receives the goods from the
common carrier.
“Shipping point” and “destination” are often designated by a
particular location, for example, f.o.b. Seoul.
GOODS INCLUDED IN INVENTORY

Consigned Goods
Example: Williams Art Gallery (the consignor) ships various art
merchandise to Sotheby’s Holdings (USA) (the consignee), who
acts as Williams’ agent in selling the consigned goods.
 Sotheby’s agrees to accept the goods without any liability,
except to exercise due care and reasonable protection from
loss or damage, until it sells the goods to a third party.
 When Sotheby’s sells the goods, it remits the revenue, less a
selling commission and expenses incurred, to Williams.
Goods out on consignment remain the property of the consignor
(Williams).
GOODS INCLUDED IN INVENTORY

Sales with Repurchase Agreements

Example: Hill Enterprises transfers (“sells”) inventory to Chase,
Inc. and simultaneously agrees to repurchase this merchandise at
a specified price over a specified period of time. Chase then uses
the inventory as collateral and borrows against it.
 Essence of transaction is that Hill Enterprises is financing its
inventory—and retains control of the inventory—even though it
transferred to Chase technical legal title to the merchandise.
 Often described in practice as a “parking transaction.”
 Hill should report the inventory and related liability on its books.
GOODS INCLUDED IN INVENTORY

Sales with Rights of Return

Example: Quality Publishing Company sells textbooks to Campus
Bookstores with an agreement that Campus may return for full
credit any books not sold. Quality Publishing should recognize
a) Revenue from the textbooks sold that it expects will not be
returned.
b) A refund liability for the estimated books to be returned.
c) An asset for the books estimated to be returned which reduces
the cost of goods sold.
If Quality Publishing is unable to estimate the level of returns, it
should not report any revenue until the returns become predictive.
COSTS INCLUDED IN INVENTORY

Product Costs
Costs directly connected with bringing the goods to the buyer’s
place of business and converting such goods to a salable
condition.

Cost of purchase includes all of:

1. The purchase price.

2. Import duties and other taxes.

3. Transportation costs.

4. Handling costs directly related to the acquisition of the goods.

COSTS INCLUDED IN INVENTORY

Period Costs
Costs that are indirectly related to the acquisition or production
of goods.

Period costs such as

 selling expenses and,
 general and administrative expenses

are not included as part of inventory cost.

COSTS INCLUDED IN INVENTORY

Treatment of Purchase Discounts

Purchase or trade discounts are reductions in the selling prices
granted to customers.

IASB requires these discounts to be recorded as a reduction

from the cost of inventories.
 Treatment of Purchase Discounts

**

Entries under Gross and * $4,000 x 2% = $80 ** $10,000 x 98% = $9,800

Net Methods
WHICH COST FLOW ASSUMPTIONS TO
ADOPT?

Cost Flow Methods

 Specific Identification
or
 Two cost flow assumptions
► First-in, First-out (FIFO) or
► Average Cost
Cost Flow Methods
To illustrate the cost flow methods, assume that Call-Mart Inc.
had the following transactions in its first month of operations.

Calculate Goods Available for Sale

Beginning inventory (2,000 x €4) € 8,000
Purchases:
6,000 x €4.40 26,400
2,000 x €4.75 9,500
Goods available for sale €43,900
Cost Flow Methods

Specific Identification
 IASB requires in cases where inventories are not ordinarily
interchangeable or for goods and services produced or
segregated for specific projects.
 Cost of goods sold includes costs of the specific items sold.
 Used when handling a relatively small number of costly,
easily distinguishable items.
 Matches actual costs against actual revenue.
 Cost flow matches the physical flow of the goods.

 May allow a company to manipulate net income.

Specific Identification
Illustration: Call-Mart Inc.’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. Compute the amount of ending
inventory and cost of goods sold.
Cost Flow Assumptions

Average-Cost
 Prices items in the inventory on the basis of the average
cost of all similar goods available during the period.

 Not as subject to income manipulation.

 Measuring a specific physical flow of inventory is often

impossible.
Average-Cost
Weighted-Average
Weighted-Average Method Method—Periodic Inventory
Average-Cost
Moving-Average Method—
Moving-Average Method Perpetual Inventory

In this method, Call-Mart computes a new average unit cost each

time it makes a purchase.
Cost Flow Assumptions

First-In, First-Out (FIFO)

 Assumes goods are used in the order in which they are
purchased.

 Approximates the physical flow of goods.

 Ending inventory is close to current cost.

 Fails to match current costs against current revenues on

the income statement.
First-In, First-Out (FIFO)

Periodic Inventory System FIFO Method—Periodic

Inventory

Determine cost of ending inventory by taking the cost of the most

recent purchase and working back until it accounts for all units in the
inventory.
First-In, First-Out (FIFO)

Perpetual Inventory System FIFO Method—

Perpetual Inventory

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.
LAST-IN, FIRST-OUT (LIFO)

Recall that Call-Mart Inc. had the following transactions in its

first month of operations.
LAST-IN, FIRST-OUT (LIFO)
LIFO Method—Periodic
Periodic Inventory System Inventory

The cost of the total quantity sold or issued during the month comes
from the most recent purchases.
LAST-IN, FIRST-OUT (LIFO)
LIFO Method—Perpetual
Perpetual Inventory System Inventory

LIFO results in different ending inventory and cost of goods sold

amounts than the amounts calculated under the periodic method.
Inventory Valuation Methods—Summary

Comparison assumes periodic inventory procedures and the

following selected data.
 Inventory Valuation Methods—Summary

Comparative Results of
Average-Cost and FIFO Notice that gross profit and net income are lowest
and LIFO Methods
under LIFO, highest under FIFO, and somewhere in
the middle under average-cost.
 Inventory Valuation Methods—Summary

Balances of Selected
Items under Alternative LIFO results in the highest cash balance at year-end
Inventory Valuation
Methods (because taxes are lower). This example assumes that
prices are rising. The opposite result occurs if prices are
declining.
1.4 LOWER-OF-COST-OR-NET REALIZABLE
VALUE (LCNRV)

A company abandons the historical cost principle when the

future utility (revenue-producing ability) of the asset drops
below its original cost.
LCNRV

Net Realizable Value

Estimated selling price in the normal course of business less
 estimated costs to complete and
 estimated costs to make a sale. Computation of Net
Realizable Value
LCNRV
Determining Final
Inventory Value

Illustration of LCNRV: Jinn-Feng Foods computes its

inventory at LCNRV (amounts in thousands).
LCNRV

Methods of Applying LCNRV Alternative Applications

of LCNRV
LCNRV

Methods of Applying LCNRV

 In most situations, companies price inventory on an item-
by-item basis.
 Tax rules in some countries require that companies use an
individual-item basis.
 Individual-item approach gives the lowest valuation for
statement of financial position purposes.
 Method should be applied consistently from one period to
another.
Recording Net Realizable Value

Illustration: Data for Ricardo Company

Cost of goods sold (before adj. to NRV) €108,000
Ending inventory (cost) 82,000
Ending inventory (at NRV) 70,000

Loss
Loss Loss Due to Decline to NRV 12,000
Method
Method Inventory (€82,000 - €70,000)

12,000
COGS
COGS Cost of Goods Sold 12,000
Method
Method Inventory

12,000
Recording Net Realizable Value

Partial Statement of Financial Position

Loss COGS
Method Method
Current assets:
Inventory € 70,000 € 70,000
Prepaids 20,000 20,000
Accounts receivable 350,000 350,000
Cash 100,000 100,000
Total current assets 540,000 540,000
Recording Net Realizable Value
Loss COGS
Income Statement Method Method
Sales € 200,000 € 200,000
Cost of goods sold 108,000 120,000
Gross profit 92,000 80,000
Operating expenses:
Selling 45,000 45,000
General and administrative 20,000 20,000
Total operating expenses 65,000 65,000
Other income and expense:
Loss due to decline of inventory to NRV 12,000 -
Interest income 5,000 5,000
Total other (7,000) 5,000
Income from operations 20,000 20,000
Income tax expense 6,000 6,000
Net income € 14,000 € 14,000
LCNRV

Use of an Allowance
Instead of crediting the Inventory account for net realizable
value adjustments, companies generally use an allowance
account.

Loss
Loss Method
Method

Loss Due to Decline to NRV 12,000

Allowance to Reduce Inventory to NRV
12,000
Use of an Allowance

Partial Statement of Financial Position

No
No
Allowance Allowance
Allowance Allowance
Current assets:
Current assets:
Inventory € 70,000 € 82,000
Inventory € 70,000 € 82,000
Allowance to reduce inventory (12,000)
Allowance to reduce inventory (12,000)
Inventory at NRV 70,000
Inventory at NRV 70,000
Prepaids 20,000 20,000
Prepaids 20,000 20,000
Accounts receivable 350,000 350,000
Accounts receivable 350,000 350,000
Cash 100,000 100,000
Cash 100,000 100,000
Total current assets 540,000 540,000
Total current assets 540,000 540,000
LCNRV

Recovery of Inventory Loss

 Amount of write-down is reversed.
 Reversal limited to amount of original write-down.

Continuing the Ricardo example, assume the net realizable

value increases to €74,000 (an increase of €4,000). Ricardo
makes the following entry, using the loss method.

Allowance to Reduce Inventory to NRV 4,000

Recovery of Inventory Loss 4,000
 Recovery of Inventory Loss

Allowance account is adjusted in subsequent periods, such

that inventory is reported at the LCNRV.
Illustration shows net realizable value evaluation for Vuko Company
and the effect of net realizable value adjustments on income.

Effect on Net Income of Adjusting

Inventory to Net Realizable Value
Evaluation of LCM Rule

LCNRV rule suffers some conceptual deficiencies:

1. A company recognizes decreases in the value of the asset
and the charge to expense in the period in which the loss in
utility occurs—not in the period of sale.
2. Application of the rule results in inconsistency because a
company may value the inventory at cost in one year and at
net realizable value in the next year.
3. LCNRV values the inventory in the statement of financial
position conservatively, but its effect on the income statement
may or may not be conservative. Net income for the year in
which a company takes the loss is definitely lower. Net
income of the subsequent period may be higher than normal if
the expected reductions in sales price do not materialize.
LCNRV
Ex. Remmers Company manufactures desks. Most of the company’s
desks are standard models and are sold on the basis of catalog prices.
At December 31, 2015, the following finished desks appear in the
company’s inventory.

Finished Desks A B C D
Catalog selling price € 500 € 540 € 900 € 1,200
FIFO cost per inventory list 12/31/15 470 450 830 960
Estimated cost to complete and sell 50 110 260 200

Instructions: At what amount should the desks appear in the company’s

December 31, 2015, inventory, assuming that the company has adopted
a lower-of-FIFO-cost-or-net realizable value approach for valuation of
inventories on an individual-item basis?
LCNRV
Ex. Remmers Company manufactures desks. Most of the company’s
desks are standard models and are sold on the basis of catalog prices.
At December 31, 2015, the following finished desks appear in the
company’s inventory.

Finished Desks A B C D
Catalog selling price € 500 € 540 € 900 € 1,200
FIFO cost per inventory list 12/31/15 470 450 830 960
Estimated cost to complete and sell 50 110 260 200
Net realizable value 450 430 640 1,000
Lower-of-cost-or-NRV 450 430 640 960
VALUATION BASES

Special Valuation Situations

Departure from LCNRV rule may be justified in situations when
 cost is difficult to determine,
 items are readily marketable at quoted market prices, and
 units of product are interchangeable.

Two common situations in which NRV is the general rule:

 Agricultural assets
 Commodities held by broker-traders.
Special Valuation Situations

Agricultural Inventory
Biological asset (classified as a non-current asset) is a living
animal or plant, such as sheep, cows, fruit trees, or cotton
plants.
 Biological assets are measured on initial recognition and
at the end of each reporting period at fair value less costs
to sell (NRV).
 Companies record gain or loss due to changes in NRV of
biological assets in income when it arises.
Special Valuation Situations

Agricultural 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.
 Agricultural produce are measured at fair value less costs
to sell (NRV) at the point of harvest.
 Once harvested, the NRV becomes cost.
Agricultural Accounting at NRV

Illustration: Bancroft Dairy produces milk for sale to local cheese-

makers. Bancroft began operations on January 1, 2015, by
purchasing 420 milking cows for €460,000. Bancroft provides the
following information related to the milking cows. Agricultural Assets—
Bancroft Dairy
Agricultural Accounting at NRV Agricultural Assets—
Bancroft Dairy

Bancroft makes the following entry to record the change in

carrying value of the milking cows.
Biological Asset (milking cows) 33,800
Unrealized Holding Gain or Loss—Income 33,800
Agricultural Accounting at NRV

Biological Asset (milking cows) 33,800

Unrealized Holding Gain or Loss—Income

33,800
Reported on the Statement of financial position as a non-
current asset at fair value less costs to sell (net realizable
value).

Reported as “Other income and expense” on the income

statement.
Agricultural Accounting at NRV

Illustration: 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
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
Sales Revenue 38,500
Cost of Goods Sold 36,000
Inventory (milk) 36,000
Special Valuation Situations

Commodity Broker-Traders
Generally measure their inventories at fair value less costs to
sell (NRV), with changes in NRV recognized in income in the
period of the change.
 Buy or sell commodities (such as harvested corn, wheat,
precious metals, heating oil).
 Primary purpose is to
► sell the commodities in the near term and
► generate a profit from fluctuations in price.
VALUATION BASES

Valuation Using Relative Standalone Sales

Value
Used when buying varying units in a single lump-sum purchase.

Illustration: 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 remaining on
hand. Calculate the cost of lots sold and gross profit.
 VALUATION BASES Allocation of Costs,
Using Relative Standalone
Sales Value

Determination of Gross Profit,

Using Relative Standalone Sales Value
VALUATION BASES

Purchase Commitments—A Special Problem

 Generally seller retains title to the merchandise.
 Buyer recognizes no asset or liability.
 If material, the buyer should disclose contract details in
note in the financial statements.
 If the contract price is greater than the market price,
and the buyer expects that losses will occur when the
purchase is effected, the buyer should recognize a
liability and corresponding loss in the period during which
such declines in market prices take place.
Purchase Commitments

Illustration: Apres Paper Co. signed timber-cutting contracts to

be executed in 2016 at a price of $10,000,000. Assume further
that the market price of the timber cutting rights on December
31, 2015, dropped to $7,000,000. Apres would make the
following entry on December 31, 2015.

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

Purchase Commitment Liability 3,000,000

Other expenses and losses in the Income statement.

Current liabilities on the balance sheet.

Purchase Commitments

Illustration: 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

Assume Apres is permitted to reduce its contract price and

therefore its commitment by $1,000,000.

Purchase Commitment Liability 1,000,000

Unrealized Holding Gain or Loss—Income 1,000,000
GROSS PROFIT METHOD OF
ESTIMATING INVENTORY

Substitute Measure to Approximate Inventory

Relies on three assumptions:

1. 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.
 GROSS PROFIT METHOD

Illustration: Cetus Corp. 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 margin method as follows.

ILLUSTRATION
Application of Gross Profit Method
 GROSS PROFIT METHOD

Computation of Gross Profit Percentage

Illustration: In the previous Illustration, the gross profit was a
given. But how did Cetus derive that figure? To see how to
compute a gross profit percentage, assume that an article cost
€15 and sells for €20, a gross profit of €5.

Computation of Gross
Profit Percentage
 GROSS PROFIT METHOD Formulas Relating
to Gross Profit

Application of
Gross Profit
Formulas
GROSS PROFIT METHOD

Illustration: Astaire Company uses the gross profit method to

estimate inventory for monthly reporting purposes. Presented below is
information for the month of May.
Inventory, May 1 € 160,000 Sales € 1,000,000
Purchases (gross) 640,000 Sales returns 70,000
Freight-in 30,000 Purchases discounts 12,000

Instructions:
(a) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of sales.
(b) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of cost.
GROSS PROFIT METHOD
(a) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of sales.

Inventory, May 1 (at cost) € 160,000

Purchases (gross) (at cost) 640,000
Purchase discounts (12,000)
Freight-in 30,000
Goods available (at cost) 818,000
Sales (at selling price) € 1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000
Less: Gross profit (25% of €930,000) 232,500
Sales (at cost) 697,500
Approximate inventory, May 31 (at cost) € 120,500
GROSS PROFIT METHOD
(b) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of cost.

Inventory, May 1 (at cost) € 160,000

Purchases (gross) (at cost) 640,000
25%
Purchase discounts = 20% of sales (12,000)
100% + 25%
Freight-in 30,000
Goods available (at cost) 818,000
Sales (at selling price) € 1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000
Less: Gross profit (20% of €930,000) 186,000
Sales (at cost) 744,000
Approximate inventory, May 31 (at cost) € 74,000

LO 5
GROSS PROFIT METHOD

Evaluation of Gross Profit Method

Disadvantages
1) Provides an estimate of ending inventory.

2) Uses past percentages in calculation.

3) A blanket gross profit rate may not be representative.

4) Normally unacceptable for financial reporting purposes

because it provides only an estimate.

IFRS requires a physical inventory as additional verification of

the inventory indicated in the records.
RETAIL INVENTORY METHOD

Method used by retailers to compile inventories at retail prices.

Retailer can use a formula to convert retail prices to cost.
Requires retailers to keep a record of:
1) Total cost and retail value of goods purchased.

2) Total cost and retail value of the goods available for sale.

3) Sales for the period.

Methods
 Conventional Method (or LCNRV)
 Cost Method
RETAIL INVENTORY METHOD

Illustration: The following data pertain to a single department for

the month of October for Fuque Inc. Prepare a schedule computing
retail inventory using the Conventional and Cost methods.

COST RETAIL
Beg. inventory, Oct. 1 £ 52,000 £ 78,000
Purchases 272,000 423,000
Freight in 16,600
Purchase returns 5,600 8,000
Additional markups 9,000
Markup cancellations 2,000
Markdowns (net) 3,600
Normal spoilage and breakage 10,000
Sales 390,000
RETAIL INVENTORY METHOD

CONVENTIONAL Method: Cost to

COST RETAIL Retail %
Beginning inventory £ 52,000 £ 78,000
Purchases 272,000 423,000
Purchase returns (5,600) (8,000)
Freight in 16,600
Markups, net 7,000
Current year additions 283,000 422,000
Goods available for sale 335,000 500,000 67.0%
Markdowns, net (3,600)
Normal spoilage and breakage (10,000)
Sales (390,000)
Ending inventory at retail £ 96,400

Ending inventory at Cost:

£ 96,400 x 67.0% = £ 64,588
RETAIL INVENTORY METHOD

COST Method: Cost to

COST RETAIL Retail %
Beginning inventory £ 52,000 £ 78,000
Purchases 272,000 423,000
Purchase returns (5,600) (8,000)
Freight in 16,600
Markdowns, net (3,600)
Markups, net 7,000
Current year additions 283,000 418,400
Goods available for sale 335,000 496,400 67.49%
Normal spoilage and breakage (10,000)
Sales (390,000)
Ending inventory at retail £ 96,400

Ending inventory at Cost:

£ 96,400 x 67.49% = £ 65,060
RETAIL INVENTORY METHOD

Special Items Relating to Retail Method

 Freight costs
 Purchase returns
 Purchase discounts and allowances
 Transfers-in
When sales are recorded
 Normal shortages
gross, companies do not
 Abnormal shortages recognize sales discounts.

 Employee discounts
 RETAIL INVENTORY METHOD

Special
Items

Conventional Retail
Inventory Method—
Special Items Included
 RETAIL INVENTORY METHOD

Evaluation of Retail Inventory Method

Used for the following reasons:
1) To permit the computation of net income without a physical
count of inventory.

2) Control measure in determining inventory shortages.

3) Regulating quantities of merchandise on hand.

4) Insurance information.

Some companies refine the retail method by computing inventory separately by

departments or class of merchandise with similar gross profits.
PRESENTATION AND ANALYSIS

Presentation of Inventories
Accounting standards require disclosure of:
1) Accounting policies adopted in measuring inventories,
including the cost formula used (weighted-average, FIFO).

2) Total carrying amount of inventories and the carrying

amount in classifications (merchandise, production supplies,
raw materials, work in progress, and finished goods).

3) Carrying amount of inventories carried at fair value less

costs to sell.

4) Amount of inventories recognized as an expense during the

period.
PRESENTATION AND ANALYSIS

Presentation of Inventories
Accounting standards require disclosure of:
5) Amount of any write-down of inventories recognized as
an expense in the period and the amount of any reversal
of write-downs recognized as a reduction of expense in
the period.

6) Circumstances or events that led to the reversal of a

write-down of inventories.

7) Carrying amount of inventories pledged as security for

liabilities, if any.
PRESENTATION AND ANALYSIS

Analysis of Inventories
Common ratios used in the management and evaluation of
inventory levels are inventory turnover and average days
to sell the inventory.
PRESENTATION AND ANALYSIS

Inventory Turnover
Measures the number of times on average a company sells
the inventory during the period.

Illustration: In its 2013 annual report Tate & Lyle plc (GBR)
reported a beginning inventory of £450 million, an ending inventory
of £510 million, and cost of goods sold of £2,066 million for the
year.
PRESENTATION AND ANALYSIS

Average Days to Sell Inventory

Measure represents the average number of days’ sales for
which a company has inventory on hand.

Average Days to Sell

365 days / 4.30 times = every 84.8 days

 GLOBAL ACCOUNTING INSIGHTS

INVENTORIES
In most cases, IFRS and U.S. GAAP related to inventory are the same. The
major differences are that IFRS prohibits the use of the LIFO cost flow
assumption and records market in the LCNRV differently.
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Following are the key similarities and differences between U.S. GAAP and
IFRS related to inventories.
Similarities
• U.S. GAAP and IFRS account for inventory acquisitions at historical cost
and evaluate inventory for lower-of-cost-or-net realizable value (market)
subsequent to acquisition.
• Who owns the goods—goods in transit, consigned goods, special sales
agreements—as well as the costs to include in inventory are essentially
accounted for the same under U.S. GAAP and IFRS.
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Differences
• U.S. GAAP provides more detailed guidelines in inventory accounting. The
requirements for accounting for and reporting inventories are more
principles-based under IFRS.
• A major difference between U.S. GAAP and IFRS relates to the LIFO cost
flow assumption. U.S. GAAP permits the use of LIFO for inventory
valuation. IFRS prohibits its use. FIFO and average-cost are the only two
acceptable cost flow assumptions permitted under IFRS. Both sets of
standards permit specific identification where appropriate.
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Differences
• In the lower-of-cost-or-market test for inventory valuation, U.S. GAAP
defines market as replacement cost subject to the constraints of net
realizable value (the ceiling) and net realizable value less a normal markup
(the floor). IFRS defines market as net realizable value and does not use a
ceiling or a floor to determine market.
• Under U.S. GAAP, if inventory is written down under the lower-of-cost-or-
market valuation, the new basis is now considered its cost. As a result, the
inventory may not be written up back to its original cost in a subsequent
period. Under IFRS, the write-down may be reversed in a subsequent
period up to the amount of the previous write-down. Both the write-down
and any subsequent reversal should be reported on the income statement.
 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Differences
• IFRS requires both biological assets and agricultural produce at the point of
harvest to be reported at net realizable value. U.S. GAAP does not require
companies to account for all biological assets in the same way.
Furthermore, these assets generally are not reported at net realizable value.
Disclosure requirements also differ between the two sets of standards.
 GLOBAL ACCOUNTING INSIGHTS

About The Numbers

Presented below is a disclosure under U.S. GAAP related to inventories,
which reflects application of U.S. GAAP to its inventories.
 GLOBAL ACCOUNTING INSIGHTS

On the Horizon
One convergence issue that will be difficult to resolve relates to the use of the
LIFO cost flow assumption. As indicated, IFRS specifically prohibits its use.
Conversely, the LIFO cost flow assumption is widely used in the United States
because of its favorable tax advantages. In addition, many argue that LIFO
from a financial reporting point of view provides a better matching of current
costs against revenue and therefore enables companies to compute a more
realistic income.
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