Intermediate Accounting 1 Chapter 9

Front 1

Proceedures under Stable Prices.

Back 1

A. Because the LIFO method is a cost method, both markups and markdowns must be considered in obtaining the proper cost-to-retail percentage. B. Since the LIFO method is concerned only with the additional layer, or the amount that should be subtracted from the previous layer, the beginning inventory is excluded from the cost to retail percentage. C. the markups and markdowns apply only to the goods purchased during the current period and not to the beginning inventory.

Front 2

Procedures under Fluctuations.

Back 2

The steps are the same as for stable prices except that in computing the LIFO inventory under a dollar value LIFOP approach, the dollar increase in inventory is found and deflated to beginning of theyear prices. If quantities increase, this increase is priced at the new index to compute the new layer. If quantities decrease, the decrease is subtracted from the most recent layers to the extent necessary.

Front 3

Describe and apply the LCM rule.

Back 3

If inventory declines in value below its original cost, for whatever reason, a company should write down the inventory to reflect this loss. The general rule is to abandon the historical cost principle when the future utility (revenue-producing ability) of the asset drops below its original cost.

Front 4

Explain when companies value inventories at net realizable value.

Back 4

Companies value inventory at net realizable value when 1. There is a controlled market with a quoted price applicable to all quantities. 2. No significant costs of disposal are involved, and 3. The cost figures are too difficult to obtain.

Front 5

Explain when companies use the relative sales value method to value inventories.

Back 5

When a company purchases a group of varying units at a single lump sum price a so called basket purchase the company may allocate the total purchase price to the individual items on the basis of relative sales value.

Front 6

Discuss accounting issues related to purchase commitments.

Back 6

Accounting for purchase commitments is controcvesial. Some argue that companies should report purchase commitment contracts as assets and liabilities at the time the contract is signed. Others believe that recognition at the delivery date is most approproate. The FASB neither excludes nor recommends the recording of assets and liabilities for purchase commitments, but it notes that if companies recorded such contracts at the time of commitment the nature of the loss and the valuation account should be reported when the price falls.

Front 7

Determine ending inventory by applying the gross profit method.

Back 7

Companies follow these seteps to determine ending inventory by appluing the gross profit method. 1. compute the gross profit percentage on selling price. 2. Compute gross profit by multiplying net sales byu the gross profit percentage. Compute COGS by subtracting gross profit from net sales. 4. Compute ending inventory by subtracting COGS from total goods available for sale.

Front 8

Average days to sell inventory

Back 8

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

Front 9

The designated Market Value

Back 9

The amount that a company compares to cost. It is always the middle value of three amounts: the replacement cost, net realizable value, and net realizable value less a normal profit margin.

Front 10

Floor

Back 10

The flor is the net realizable value less a normal profit margin.

Front 11

LCM

Back 11

A company values its 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.

Front 12

Net realizable value

Back 12

The estimated selling price in the ordinary course of business, less reasonably predictable costs of completion and disposal. Often referred to as net selling price.

Front 13

Market value and how to calculate it

Back 13

Market value is the middle of 3 numbers. NRV, NRV-NP and RC
NRV= SP - Disposal cost
NRV-NP
RC

Front 14

Theoretical merits

Back 14

A change in replacement cost usually is a good indicator of the direction of change in selling price. If previously acquired inventory is revalued at replacement cost, then the profit margin realized on its sale will likely approximate the profit margin realizable on the sale of newly acquired items.

Front 15

How must LCM be applied for income tax purposes?

Back 15

For income tax purposes, LCM must be applied on an individual item basis.

Front 16

Adjusting cost to market

Back 16

When a company applies the LCM rule and a material write down of inventory is required, the company has 2 choices of how to report the reduction.
Loss on write down of inventory
Inventory
OR
COGS
Inventory

Front 17

How do you choose which adjusting inventory entry to make?

Back 17

If inventory write downs are a normal part of operations, then it will be included in losses as COGS. If it is abnormal it should be identified as a loss on inventory.

Front 18

If inventory recovers its value can you write it back up?

Back 18

GAAP - NOT ALLOWED
IFRS - Can write inventory back up if value accrues.

Front 19

Gross profit method

Back 19

Useful where estimates of inventory are desirable. Provides only an approximation of inventory and is not accepted in GAAP

Front 20

When using Gross profit inventory estimation techinque

Back 20

step 1 is to estimate COGS. This is based on a historical relationship between net sales, COGS, and gross profit.

Front 21

Difficulty/shortfalls of Gross profit estimation

Back 21

it does not consider possible theft or spoilage of inventory. Assumes that if the inventory was not sold, it is on hand at the end of the period.

Front 22

Retail inventory method

Back 22

similar to GP metho din that it relies on relationship between selling price to estimate ending inventory and COGS.

Front 23

Cost to retail percentage

Back 23

Cost of inventory / Retail value of inventory

Front 24

Retail inventory method

Back 24

provides a more accurate method than GP because it is based on the current cost to retail percentage rather than on a historical gross profit ratio. The increased reliability in the estimate is achieved by comparing he COGA for sale at cost with the COGA for sale at retail. The retail inventory method estimates the amount of ending inventory (at retail) by subtracting sales (at retail) from goods available for sale (at retail). This estimated eI at retail is then converted to cost by multiplying it by the cost to retail percentage this ratio is found by dividing COGA at cost / COGA at retail.

Front 25

Which method is acceptable for financial reporting

Back 25

Retail inventory method can be used for external financial reporting.

Front 26

Initial markup

Back 26

Original amount of markup from cost to selling price.

Front 27

Additional markup

Back 27

increase in selling price subsequent to initial markup

Front 28

markup cancellation

Back 28

elimination of additional markup

Front 29

markdown

Back 29

reduction in selling price below original selling price

Front 30

markdown cancellation

Back 30

elimination of markdown

Front 31

retail inventory method average cost

Back 31

include markups and markdowns when calculating this cost to retail percentage

Front 32

conventional retail method

Back 32

we apply the method by excluding markdowns from the calculation for cost to retail percentage. Markdowns still are subtracted in the retail colum but only after the percentage is calculated. This causes the cost to retail percentage to be lower than previously.

Front 33

change in inventory metod

Back 33

most voluntary changes require financial statements to be restated retroactively. Changes in inventory methods except a change to LIFO are treated this way.

Front 34

The journal entry to adjust financial statements

Back 34

is a debit or credit to inventory and a debit or credit to retained earnings.

Front 35

When a company changes to LIFO

Back 35

Impossible to calculate income effect on prior years. To do so would require assumptions as to when specific LIFO inventory layers were created in years prior to thc change. AS a result companies changing to LIFO don't report these changes. A disclosure note is needed to explain the nature of and justification for the change, the effect of the change on current net income, and why the retrpspective application was impractible.

Front 36

inventory errors if discovered in same acct period it occureed

Back 36

origial entry is reversed and appropriate entry recorded,.

Front 37

if inventory error is discovered in an acct period subsequent ot period in wihcih it was made

Back 37

Pervious years fiancial statements that were incorrect must be restated to reflect the change.

Front 38

If the error is discovered subsequent to the following year

Back 38

financial statements are retrospectively restated even though they do not need a journal entry. INventory and r/e don't need an adjustment. The error has self corrected.

Front 39

Overstate EI

Back 39

understates COGS and overstates NI

Front 40

understatement of EI

Back 40

Overstates COGS
understates NI

Front 41

overstate BI

Back 41

overstate COGS
Understate NI

Front 42

understate BI

Back 42

understate COGS
Overstate NI

Front 43

Overstate purchases

Back 43

Overstate COGS
Understate NI

Front 44

understate purchases

Back 44

understate COGS
overstate NI