intermediate accounting spiceland 5th 6th 7th edition solution Chap009.docx
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intermediateaccountingspiceland5th6th7theditionsolutionChap009
Chapter9Inventories:
AdditionalIssues
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.
AnswerstoQuestions(continued)
Question9-13
Freight-inisaddedtopurchasesinthecostcolumn.Netmarkupsareaddedintheretailcolumnbeforethecalculationofthecost-to-retailpercentage.Normalspoilageisdeductedintheretailcolumnafterthecalculationofthecost-to-retailpercentage.Ifsalesarerecordednetofemployeediscounts,thediscountsaredeductedintheretailcolumn.
Question9-14
Thedollar-valueLIFOretailmethodeliminatesthestablepriceassumptionofregularretailLIFO.Ineffect,itcombinesdollar-valueLIFO(Chapter8)withLIFOretail.Beforecomparingbeginningandendinginventoryatretailprices,endinginventoryisdeflatedtobaseyearretailusingthecurrentyear’sretailpriceindex.Afteridentifyingthelayersinendinginventorywiththeyearstheywerecreated,inadditiontoconvertingretailpricestocostusingthecost-to-retailpercentage,thedollar-valueLIFOmethodrequiresthateachlayerfirstbeconvertedfrombaseyearretailtolayeryearretailusingtheyear’sretailpriceindex.
Question9-15
Changesininventorymethods,otherthanachangetotheLIFOmethod,arereportedretrospectively.Thismeansreportingallpreviousperiods’financialstatementsasifthenewinventorymethodhadbeenusedinallpriorperiods.
Question9-16
WhenacompanychangestotheLIFOinventorymethodfromanyothermethod,itusuallyisimpossibletocalculatetheincomeeffectonprioryears.TodosowouldrequireassumptionsastowhenspecificLIFOinventorylayerswerecreatedinyearspriortothechange.Asaresult,acompanychangingtoLIFOusuallydoesnotreportthechangeretrospectively.Instead,theLIFOmethodsimplyisusedfromthatpointon.ThebaseyearinventoryforallfutureLIFOdeterminationsisthebeginninginventoryintheyeartheLIFOmethodisadopted.
Question9-17
Ifamaterialinventoryerrorisdiscoveredinanaccountingperiodsubsequenttotheperiodinwhichtheerrorismade,anypreviousyears’financialstatementsthatwereincorrectasaresultoftheerrorareretrospectivelyrestatedtoreflectthecorrection.And,ofcourse,anyaccountbalancesthatareincorrectasaresultoftheerrorarecorrectedbyjournalentry.Ifretainedearningsisoneoftheincorrectaccounts,thecorrectionisreportedasapriorperiodadjustmenttothebeginningbalanceinthestatementofshareholders’equity.Inaddition,adisclosurenoteisneededtodescribethenatureoftheerrorandtheimpactofitscorrectiononnetincome,incomebeforeextraordinaryitem,andearningspershare.
AnswerstoQuestions(concluded)
Question9-18
2009:
Costofgoodssoldoverstated
Netincomeunderstated
Endingretainedearningsunderstated
2010:
Netpurchasesnoeffect
Costofgoodssoldunderstated
Netincomeoverstated
Endingretainedearningscorrect
Question9-19
Whenapplyingthelower-of-cost-or-marketruleforvaluinginventoryaccordingtoU.S.GAAP,marketisdefinedasreplacementcostwithaceilingofnetrealizablevalue(NRV)andafloorofNRVlessanormalprofitmargin.However,thedesignatedmarketvalueaccordingtoIASNo.2alwaysisnetrealizablevalue.IASNo.2alsospecifiesthatifcircumstancesrevealthataninventorywrite-downisnolongerappropriate,itmustbereversed.ReversalsarenotpermittedunderU.S.GAAP.
Question9-20
Purchasecommitmentsarecontractsthatobligatethecompanytopurchaseaspecifiedamountofmerchandiseorrawmaterialsatspecifiedpricesonorbeforespecifieddates.Theseagreementsareenteredintoprimarilytosecuretheacquisitionofneededinventoryandtoprotectagainstincreasesinpurchaseprice.
Question9-21
Purchasesmadepursuanttoapurchasecommitmentarerecordedatthelowerofcontractpriceormarketpriceonthedatethecontractisexecuted.Alossisrecognizedifthemarketpriceislessthanthecontractprice.Forpurchasecommitmentsoutstandingatyear-end,alossisrecognizedifthemarketpriceatyear-endislessthanthecontractprice.
BRIEFEXERCISES
BriefExercise9-1
NRV=$30-4=$26
NRV–NP=$26–(30%x$30)=$17
RC=$18
ThedesignatedmarketisthemiddlevalueofNRV,NRV-NP,andRC,whichis$18.Sincethisislowerthanthecostof$20,theunitvalueis$18.
BriefExercise9-2
(1)
(2)
(3)
(4)
(5)
Product
RC
Ceiling
NRV(*)
Floor
NRV-NP
(**)
DesignatedMarketValue
[Middlevalueof
(1),
(2)&(3)]
Cost
PerUnit
InventoryValue
[Lowerof(4)and(5)]
1
$48
$64
$54
$54
$50
$50
2
26
32
24
26
30
26
*Sellingpricelessdisposalcosts.
**NRVlessnormalprofitmargin
CostLCM
Product1(1,000units)$50,000$50,000
Product2(1,000units)30,00026,000
Cost$80,000
LCMvalue$76,000
Before-taxincomewillbelowerby$4,000,theamountoftherequiredinventorywrite-down.
BriefExercise9-3
ThedesignatedmarketvalueaccordingtoIFRSalwaysisnetrealizablevalue.
ProductCostNRV*LCM
1$50$64$50
2.303230
*Sellingpricelessdisposalcosts.
Becausecostislowerthanmarketforbothproducts,n