Inventories: Additional Issues Discuss and answer two of the questions or cases

Question

Inventories: Additional Issues

Discuss and answer two of the questions or cases listed below in detail:

1. Huddell Co., which is both a wholesaler and retailer, purchases merchandise from various suppliers. The dollar-value LIFO method is used for the wholesale inventories. Huddell determines the estimated cost of its retail ending inventories using the conventional retail inventory method, which approximates lower of average cost or market.

a. What are the advantages of using the dollar-value LIFO method as opposed to the traditional LIFO method?

b. How does the application of the dollar-value LIFO method differ from the application of the traditional LIFO method?

2. Explain the LIFO retail inventory method. What is the conventional retail method?

3. Explain the a) lower of cost or net realizable value (LCNRV) approach and the b) lower of cost or market (LCM) approach to valuing inventory.

4. Explain the accounting treatment of material inventory errors discovered in an accounting period subsequent to the period in which the error is made.

5. Both the gross profit method and the retail inventory method provide a way to estimate ending inventory. What is the main difference between the two estimation techniques.

6. Describe the alternative approaches for recording inventory write-downs.

Explanation / Answer

A.  If your business sells merchandise from inventory, your choice of cost flow assumption can affect your gross profits. The Internal Revenue Service allows you to use the first-in, first-out method or the last-in, first-out method -- FIFO and LIFO. If you choose LIFO, you can further select from one of several submethods, including dollar-value LIFO, or DVL.

Dollar-Value LIFO

B.Under DVL, you don’t view your inventory as a quantity of physical goods. Instead, you consider your inventory as a quantity of value consisting of annual layers. Each layer is a pool of the entire inventory you purchase during the year. You don’t base your ending inventory value on the count of items, but rather on the dollar value of those items. The DVL method determines the dollar value of your inventory by starting with your initial ending inventory for the year you adopted the method, and then adjusting it for annual changes in inventory value after removing the effects of inflation.The DVL method provides several advantages over other LIFO methods.

2. An accounting procedure for estimating the value of a store's merchandise. This method calculates a store's total inventory value by taking the total retail value of the items that were originally in inventory, subtracting the total sales, then multiplying that dollar amount by the cost-to-retail ratio (the percentage by which goods are marked up from their wholesale purchase price to their retail sales price).
Conventional Retail Method

Businesses rely on a number of accounting methods to help them estimate the value of current assets such as inventory. The conventional retail inventory method calculates an asset’s value by applying a factor to extrapolate known information about inventory. The CRIM is accurate only to the extent you use consistent and relevant historical data to make an estimate.

3.

Application of LCNRV rule can be done individual item basis, group basis or on overall basis. What basis entity must use depends on the nature of inventory itself and management’s policy.

For example if product can be sold individually and its selling price and related costs and can be determined independently then for this product LCNRV rule will be applied on individual basis. If product is of such nature that its NRV cannot be determined on individual basis as it has to be sold with other products as a package then rule will be applied on group basis. And if entity manages inventory as a whole then rule will be applied on totality basis on all types of inventory taken together.

However, there is no restriction to apply LCNRV rule on different basis only if nature of product and sales is different. Entity may group similar types of products together and apply the rule on group basis even if items can be sold individually.

NRV, in the context of inventory, is the estimated selling price in the normal course of business, less reasonably predictable costs of completion, disposal, and transportation. Obviously, these measurements can be somewhat subjective, and may require the exercise of judgment in their determination. It is also important to note that a company using LIFO or the retail method (as described in the next section of this chapter) would not use the lower-of-cost-or-NRV method, but would instead value inventory at lower of cost or “market.” Substitution of the word “market” entails subtle technical distinctions, the details of which are usually covered in more advanced accounting classes.

It is noteworthy that the lower-of-cost-or-NRV adjustments can be made for each item in inventory, or for the aggregate of all the inventory. In the latter case, the good offsets the bad, and a write-down is only needed if the overall value is less than the overall cost. In any event, once a write-down is deemed necessary, the loss should be recognized in income and inventory should be reduced. Once reduced, the Inventory account becomes the new basis for valuation and reporting purposes going forward. Unlike international reporting standards, U.S. GAAP does not permit a write-up of write-downs reported in a prior year, even if the value of the inventory has recovered.

5.

Gross Profit Method

The gross profit method calculation starts with the value of the goods in your inventory the last time you performed a physical count. Remember that the "value" of inventory represents the cost to you, not the retail price. Say you had inventory worth $50,000 the last time you did a hand-count. Now add the amount you have spent on goods since that count. If you've spent $30,000 since then, the total cost of goods available for sale is $80,000. Next, look at your sales revenue since the last inventory. This amount will reflect the retail price of the goods sold. Say you had $60,000 in sales. Apply your gross profit margin to your sales revenue to determine the cost of the goods you sold. If your margin is 25 percent, then that $60,000 in sales represents $15,000 in profit and $45,000 in costs. Subtract that cost figure from the total cost of available goods: $80,000 minus $45,000 gives you an estimated current inventory value of $35,000.

Retail Inventory Method

The calculation for the retail inventory method works much the same as that for the gross profit method. Start with the inventory cost at the last hand-count and then add to that the cost of goods purchased since the count. Say these two add up to $80,000. Now take your sales revenue since the last inventory, and calculate how much of that was the cost of the goods and how much was markup. If you had $60,000 in sales and your markup is 25 percent, then those sales represent $48,000 in costs and $12,000 in markup ($12,000 is 25 percent of $48,000). Subtract $48,000 from $80,000, and your estimated current inventory is $32,000.

6. Gross profit method

Retail Inventory Method

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