PREVIEW OF CHAPTER 4

SECTION 1
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 Manufacturing
or
Company Company
Inventory Issues
ILLUSTRATION 4-1
Classification
 One inventory
account.
 Purchase
merchandise in
a form ready
for sale.
Inventory Issues
ILLUSTRATION 4-1
Classification
Three accounts

 Raw Materials

 Work in Process

 Finished Goods
Inventory Issues ILLUSTRATION 4-2
Flow of Costs through

Classification Manufacturing and

Merchandising Companies
Inventory Issues
Inventory Cost Flow
ILLUSTRATION 4-1

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 ILLU: 4-4 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.

ILLUSTRATION 4-5 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.

ILLUSTRATION 4-6 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.
Goods Included In Inventory
Effect of Inventory Errors ILLUSTRATION 4-7
Financial Statement
Effects of Misstated
Ending Inventory Misstated Ending Inventory

The effect of an error on net income in one year will be

counterbalanced in the next, however the income statement
will be misstated for both years.
 Ending Inventory Misstated
Illustration: Yei Chen Corp. understates its ending inventory by
HK$10,000 in 2015; all other items are correctly stated.
ILLUSTRATION 4-8
Effect of Ending Inventory
Error on Two Periods
Goods Included In Inventory
Effect of Inventory Errors ILLUSTRATION 4-9
Financial Statement
Effects of Misstated
Purchase and Inventory Misstated Purchases and Inventory

The understatement does not affect cost of goods sold

and net income because the errors offset one another.
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

**

ILLUSTRATION 4-11
* $4,000 x 2% = $80 ** $10,000 x 98% = $9,800
Entries under Gross and
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.
ILLUSTRATION 4-12
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
ILLUSTRATION 4-13
Weighted-Average Method Weighted-Average
Method—Periodic Inventory
Average-Cost
ILLUSTRATION 4-14
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 ILLUSTRATION 4-15 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 ILLUSTRATION 4-16 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.
Inventory Valuation Methods—Summary
Comparison assumes periodic inventory procedures and
the following selected data.
Inventory Valuation Methods—Summary

ILLUSTRATION 4-17
Comparative Results of
Average-Cost and FIFO
Methods
Inventory Valuation Methods—Summary
When prices are rising, average-cost results in the higher
cash balance at year-end (because taxes are lower).

ILLUSTRATION 4-18
Balances of Selected Items under Alternative Inventory Valuation Methods
PREVIEW OF CHAPTER 7

SECTION 2
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 (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. ILLUSTRATION 4-1-1
Computation of Net
Realizable Value
LCNRV
Net Realizable Value ILLUSTRATION 4-1-2
LCNRV Disclosures
LCNRV
Illustration of LCNRV: Jinn-Feng Foods computes its
inventory at LCNRV (amounts in thousands). ILLUSTRATION 4-1-3
Determining Final
Inventory Value
LCNRV
Methods of Applying LCNRV ILLUSTRATION 4-1-4
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 Due to Decline to NRV 12,000

Method Inventory (€82,000 - €70,000) 12,000

CoGS Cost of Goods Sold 12,000

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
Income Statement Loss COGS
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 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
Allowance Allowance
Current assets:
Inventory € 70,000 € 82,000
Allowance to reduce inventory (12,000)
Inventory at NRV 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
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.

ILLUSTRATION 4-1-8
Effect on Net Income of Adjusting
Inventory to Net Realizable Value
Evaluation of LCNRV 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
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
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 NRV

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 Inventory NRV

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.
ILLUSTRATION 4-1-9 Agricultural Assets— Bancroft Dairy
Agricultural Accounting at NRV
ILLUSTRATION 4-1-9 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 NRV
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 ILLUSTRATION 4-1-10
Allocation of Costs,
Using Relative Standalone Sales Value

ILLUSTRATION 4-1-11
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 4-1-13
Application of Gross Profit Method
Gross Profit Method
Computation of Gross Profit Percentage
Illustration: In Illustration 9-13, 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.

ILLUSTRATION 4-1-14
Computation of Gross Profit Percentage
 Gross Profit Method
Illustration 4-1-15 Formulas Relating to Gross Profit

Illustration 9-16
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
Purchase discounts 25% (12,000)
= 20% of sales
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
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
Special Items Relating to Retail Method
 Freight costs
 Purchase returns
 Purchase discounts and allowances
 Transfers-in
 Normal shortages When sales are recorded
 Abnormal shortages gross, companies do not
recognize sales
 Employee discounts
discounts.
 Retail Inventory Method
Special
Items

ILLUSTRATION 4-1-22
Conventional Retail
Inventory Method—
Special Items
Included
Retail Inventory Method
Exercise: 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
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.
Illustration 4-1-25
Presentation and Analysis
Average Days to Sell Inventory
Measure represents the average number of days’ sales for
which a company has inventory on hand.
Illustration 4-1-25

Average Days to Sell

365 days / 4.30 times = every 84.8 days

The End of Chapter 4
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