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QuestionsforReviewofKeyTopics
Question9-1
GAAPgenerallyrequiretheuseofhistoricalcosttovalueassets,butadeparturefromcostisnecessarywhentheutilityofanassetisnolongerasgreatasitscost.Theutilityorbenefitsfrominventoryresultfromtheultimatesaleofthegoods.Thisutilitycouldbereducedbelowcostduetodeterioration,obsolescence,orchangesinpricelevels.Toavoidreportinginventoryatanamountgreaterthanthebenefitsitcanprovide,thelower-of-cost-or-marketapproachtovaluinginventorywasdeveloped.Thisapproachresultsintherecognitionoflosseswhenthevalueofinventorydeclinesbelowitscost,ratherthanintheperiodinwhichthegoodsareultimatelysold.
Question9-2
ThedesignatedmarketvalueintheLCMruleisthemiddlenumberofreplacementcost(RC),netrealizablevalue(NRV)andnetrealizablevaluelessanormalprofitmargin(NRV-NP).ThisistheamountcomparedwithcosttodetermineLCM.
Question9-3
TheLCMdeterminationcanbemadebasedonindividualinventoryitems,onlogicalcategoriesofinventory,orontheentireinventory.
Question9-4
Thepreferredmethodistorecordthelossfromthewrite-downofinventoryasaseparateitemintheincomestatementratherthanincludingthewrite-downincostofgoodssold.Alessdesirablealternativeistoincludethelossincostofgoodssold.
Question9-5
Thegrossprofitmethodestimatescostofgoodssold,whichisthensubtractedfromcostofgoodsavailableforsaletoobtainanestimateofendinginventory.Theestimateofcostofgoodssoldisfoundbymultiplyingsalesbythehistoricalratioofcosttosellingprices.Thecostpercentageisthereciprocalofthegrossprofitratio.
Question9-6
Thekeytoobtainingaccurateestimateswhenusingthegrossprofitmethodisthereliabilityofthecostpercentage.Ifthecostpercentageistoolow,costofgoodssoldwillbeunderstatedandendinginventoryoverstated.Costpercentagesusuallyarebasedonrelationshipsofpastyears,whicharen’tnecessarilyrepresentativeofthecurrentrelationship.Failuretoconsidertheftorspoilagealsocouldcauseanoverstatementofendinginventory.
AnswerstoQuestions(continued)
Question9-7
Theretailinventorymethodfirstdeterminestheamountofendinginventoryatretailbysubtractingsalesfortheperiodfromgoodsavailableforsaleatretail.Endinginventoryatretailisthenconvertedtocostbymultiplyingitbythecost-to-retailpercentage.
Question9-8
Themaindifferencebetweenthegrossprofitmethodandtheretailinventorymethodisinthedeterminationofthecostpercentageusedtoconvertsalesatsellingpricestosalesatcost.Theretailinventorymethodusesacostpercentage,calledthecost-to-retailpercentage,whichisbasedonacurrentrelationshipbetweencostandsellingprice.Thegrossprofitmethodreliesonpastdatatoreflectthecurrentcostpercentage.
Question9-9
Initialmarkup—Originalamountofmarkupfromcosttosellingprice.
Additionalmarkup—Increaseinsellingpricesubsequenttoinitialmarkup.
Markupcancellation—Eliminationofanadditionalmarkup.
Markdown—Reductioninsellingpricebelowtheoriginalsellingprice.
Markdowncancellation—Eliminationofamarkdown.
Question9-10
Whenusingtheretailmethodtoestimateaveragecost,thecost-to-retailpercentageisdeterminedbydividingtotalcostofgoodsavailableforsalebytotalgoodsavailableforsaleatretail.Byincludingbeginninginventoryinthecalculationofthecost-to-retailpercentage,thepercentagereflectstheaveragecost/retailrelationshipforallinventories,notjusttheportionacquiredinthecurrentperiod.
Question9-11
Thelower-of-cost-or-market(LCM)retailvariationcombinedwiththeaveragecostmethodiscalledtheconventionalretailmethod.TheLCMruleisincorporatedintotheretailinventoryestimationprocedurebyexcludingmarkdownsfromthecalculationofthecost-to-retailpercentage.
Question9-12
WhenapplyingLIFO,ifinventoryincreasesduringtheyear,noneofthebeginninginventoryisassumedsold.Endinginventoryincludesthebeginninginventoryplusthecurrentyear’slayer.Todeterminelayers,wecompareendinginventoryatretailtobeginninginventoryatretailandassumethatnomorethanoneinventorylayerisaddedifinventoryincreases.Eachlayercarriesitsowncost-to-retailpercentagethatisusedtoconverteachlayerfromretailtocost.
Question9-13
Freight-inisaddedtopurchasesinthecostcolumn.Netmarkupsareaddedintheretailcolumnbeforethecalculationofthecost-to-retailpercentage.Normalspoilageisdeductedintheretailcolumnafterthecalculationofthecost-to-retailpercentage.Ifsalesarerecordednetofemployeedis