Simple 1 01 5 E-lower-of-cost-or-market. Simplifies E-lower-of-cost-or- marketable entries. Simplifies Egg-SLower-of-cost-or-Americanization account. Moderateness E-lower-of-cost-or-marketer effect. Simplifies Egg-reiterative sales value method. Simple 520 E-reiterative sales value method. Simplifies E-purchase commitments. Simplifies E-1 Purchase commitments. Simple 520 E-I I Gross profit method Simplexes EEL gross profit method. Simple 1015 E-gross profit method. Simple 1520 E-gross profit method. Moderate 1520 E-gross profit method. Simplifies S E-gross profit method.
Simple 1520 E-gross profit method. Moderateness E-1 retail inventory method. Moderateness 1 retail inventory method. Simplifies E-retail inventory method. Simplifies E-analysis of inventoriesSimple101SE9Q2Retail inventory nondenominational and LIFO,Moderate IEEE-retail inventory nondenominational and LIFO. Moderate IEEE-dollar-Aviva LIFO retail. Simple 0158250011ar. EIA LIFO retail,Simplest OWE-conventional retail and dollar-value L IF-O retail. Moderateness-dollar-value LIFO retail. Moderateness-exchange to LIFO retail,Simplifies pig-l Lower-of-cost-or-market,Simplest pig-allover-of- cost-or-market.
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Moderateness PA-entries for lower-of-cost-or-markets-of- good-sold and loss_Moderateness pig-gross profit method. Moderateness PA-gross profit method. Complexions PA-retail inventory method. Moderateness Pig-retail inventory method. Moderateness ASSIGNMENT CHARACTERISTICS TABLE (Continued) Demonstrativeness’s of Difficulties (minutes) pig-retail inventory method. Moderateness Pig-statement and note disclosure, LLC, and purchase commitment. Moderateness PA-lower-of-cost- or-market. Moderateness’s-I I Conventional and dollar-value LIFO retail. Moderateness’s-retail, LIFO retail. ND inventory shortage.
Moderateness’s-exchange to LIFO retail. Moderateness’s-exchange to LIFO retail dollar-value LIFO retail. Complexions CA-lower-of-cost-or- market. Moderateness CA-lower. Of. Cost. Or. Market. Moderateness CA-lower-of-cost-or-market. Moderateness Certainly inventory method. Moderateness CA-cost determination, LLC, retail method. Moderateness CA-purchase commitments. Moderateness SOLUTIONS TO CODIFICATION EXERCISES ICE-1 (a) According to the Master Glossary, Inventory is defined as the aggregate of those items of tangible personal property that have any tooth tolling characteristics 1.
Held tort sale in the ordinary course of business 2. In process of production for such sale 3. To be currently consumed in the production to goods or services to be available for sale, The term inventory embraces goods awaiting sale (the merchandise of a trading concern and the finished goods of a manufacturer), goods in the course of production (norm in process), and goods to be consumed directly or indirectly in production (raw materials and supplies). This definition of inventories excludes long-term assets subject to depreciation accounting, or goods which, when put into use, will be so classified.
The fact that a depreciable asset is retired from regular use and held for sale does not indicate that the item should be classified as part of the inventory. Raw materials and supplies purchased for production may be used or consumed for the construction Of long-term assets or Other purposes not related to production, but the fact that inventory items representing a small portion Of the total may not be absorbed ultimately in the production process does not require separate classification.
By trade practice, operating materials and supplies of certain types of entities such as oil producers are usually treated as inventory. B) According to the Master Glossary, the phrase lower-of-cost. Or. Market, the term market means current replacement cost (by purchase or by reproduction, as the case may be) provided that it meets both of the following conditions. 1. Market shall not exceed the net realizable value 2. Market shall not be less than net realizable value reduced by an allowance for an approximately normal profit margin. C)According to the Master Glossary, two definitions are provided for the phrase net realizable value l. Estimated selling price in the ordinary course to business less reasonably predictable costs of implosion and disposal, 2, Valuation of inventories at estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The second definition provides a link to guidance for lower-of-cost-or-market in the agricultural industry (FAST ASS 905-330-35) Growing Crops 35-1 Costs of growing crops shall be accumulated until the time of harvest.
Growing crops shall be reported at the lower-of-cost-or-market. Developing Animals 35-2 Developing animals to be held for sale shall be valued at the lower-of-cost-or-market. ICE-1 (Continued) Animals Available and Held for Sale 35-3 Animals held for sale shall be valued at either of the following (a) The lower-of-cost-or-market (b) At sales price less estimated costs of disposal, if all the following conditions exist I . The product has a reliable, readily determinable, and realizable market price. 2. The product has relatively insignificant and predictable costs Of disposal. . The product is available for immediate delivery. Inventories of harvested crops and livestock held for sale and commonly referred to as valued at market are actually valued at net realizable value. Harvested Crops 35-4 Inventories of harvested crops shall be valued using the same criteria as animals held for sale in the preceding paragraph. ICE-2 According to FAST ASS 330-10-35-1 through 5 Adjustments to Lower-of-cost-or-Market A departure from the cost basis of pricing the inventory is required when the utility of the goods is no longer as great as their cost.
Where there is evidence that the utility of goods, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the difference shall be recognized as a loss of the current erred. This is generally accomplished by stating such goods at a lower level commonly designated as market. Thus, in accounting for inventories, a loss shall be recognized whenever the utility of goods is impaired by damage, deterioration, obsolescence, changes in price levels, or other causes.
The measurement of such losses shall be accomplished by applying the rule of pricing inventories at the lower-of-cost-or-market. This provides a practical means of measuring utility and thereby determining the amount of the loss to be recognized and accounted for in the current period. However, utility is indicated armorial by the current cost of replacement Of the goods as they would be obtained by purchase or reproduction. In applying the rule, however, judgment must always be exercised and no loss shall be recognized unless the evidence indicates clearly that a loss has been sustained.
Replacement or reproduction prices would not be appropriate as a measure Of utility when the estimated sales value, reduced by the costs of completion and disposal, is lower, in which case the realizable value so determined more appropriately measures utility. In addition, when the evidence indicates that cost will be recovered with an approximately normal profit upon sale in the ordinary course of business, no loss shall be recognized even though replacement or reproduction costs are lower.
This might be true, for example, in the case of production under firm sales contracts at fixed prices, or when a reasonable volume of future orders is assured at stable selling prices. In summary, the determination of the amount of the write-off should be based on factors that relate to the net realizable value of the inventory, not the amount that will maximize the loss in the current period. Note that the sale managers proposed accounting is an example of cookie jar serves, as discussed in Chapter 4. Rating the inventory down to an unsupported low value, the company can report higher gross profit and net income in subsequent periods when the inventory is sold. ICE-3 According to PASS ASS 330-10-35-6, if inventory has been the hedged item in a fair value hedge, the inventory cost basis used in the lower-of-cost-or-market accounting shall reflect the effect of the adjustments of its carrying amount made pursuant to paragraph 81 5-25-35-l(b).
And, according to 815-2-35-1 (b), gains and losses on a qualifying fair value hedge shall be accounted for as follows The gain or loss that is, the change in fair value) on the hedged item attributable to the hedged risk shall adjust the carrying amount Of the hedged item and be recognized currently in earnings. ICE-4 see FAST ASS 210-10-regulation S-X Rule 5-02, Balance Sheets ASS-I The following is the text Of Regulation S-X Rule 5-02, Balance Sheets.
The purpose of this rule is to indicate the various line items and certain additional disclosures Which, if applicable, and except as otherwise permitted by the Commission. Should appear on the face of the balance sheets or related notes filed for the persons to whom this article pertains (see 10. 401(a)). ASSETS AND OTHER DEBITS current Assets, when appropriate see 210. 405 6. Inventories. (a) State separately in the balance sheet or in a note thereto, if practicable, the amounts of major classes of inventory such as 1.
Finished goods 2. Inventoried cost relating to long-term contracts or programs (see (d) below and 210. 405) 3. Work in process (see 210. 405) 4 raw materials and 5. Supplies. It the method of calculating a LIFO inventory does not allow for the practical determination of amounts assigned to major classes of inventory, the amounts of those classes may be stated under cost flow assumptions other that LIFO with the excess of such total amount over the aggregate LIFO amount shown as a deduction to arrive at the amount of the LIFO inventory. B) The basis of determining the amounts shall be stated. If cost is used to determine any portion of the inventory amounts, the description of this method shall include the nature of the cost elements included in inventory. Elements of cost include, among other items, retained costs representing the excess Of manufacturing or production costs over the amounts charged to cost Of sales or delivered or in-process units, initial tooling or other deferred startup sots, or general and administrative COStS_ The method by Which amounts are removed from inventory (e. . , average cost, first-in, first-out, last-in, first-out, estimated average cost per unit) shall be described. If the estimated average cost per unit is used as a basis to determine amounts removed from inventory under a total program or similar basis of accounting, the principal assumptions (including. Where meaningful, the aggregate number of units expected to be delivered under the program, the number of units delivered to date and the number of units on order) shall he disclosed.
ICE-4 (Continued) If any general ND administrative costs are charged to inventory, state in a note to the financial statements the aggregate amount of the general and administrative costs incurred in each period and the actual or estimated amount remaining in inventory at the date of each balance sheet. (c) If the LIFO inventory method is used, the excess to replacement or current cost over stated LIFO value shall, if material, be stated parenthetically or in a note to the financial statements. (d) For purposes of 210. 502. 3 and 210. 502. 6, long-term contracts or programs include l. Al contracts or programs for which gross profits are recognized on a argental- of-completion method of accounting or any variant thereof (e. G. , delivered unit, cost to cost, physical completion), and 2. Any contracts or programs accounted for on a completed contract basis of accounting where, in either case, the contracts or programs have associated with them material amounts of inventories or unbilled receivables and where such contracts or programs have been or are expected to be performed over a period of more than twelve months. Contracts or programs of shorter duration may also be included, if deemed appropriate. Or all long-term contracts or programs, the following information, if applicable, shall be stated in a note to the financial statements (i) The aggregate amount Of manufacturing or production costs and any related deferred costs (e. G. , initial tooling costs) which exceeds the aggregate estimated cost Of all unprocessed and delivered units on the basis Of the estimated average cost of all units expected to be produced under long-term contracts and programs not yet complete, as well as that portion of such amount which would not be absorbed in cost of sales on existing firm orders at the latest balance sheet date.
In addition, if practicable, disclose the amount of deferred costs by yep of cost (e. G. , initial tooling, deferred production, etc,) (ii) The aggregate amount representing claims or other similar items subject to uncertainty concerning their determination or ultimate realization, and include a description to the nature and status to the principal items comprising such aggregate amount. (iii) The amount of progress payments netted against inventory at the date of the balance sheet. ANSWERS TO QUESTIONS 1.
Where there is evidence that the utility of goods to be disposed of in the ordinary course of business will be less than cost, the difference should be recognized as a loss in the current erred, and the inventory should be stated at market value in the financial statements. 2. The upper (ceiling) and lower (floor) limits for the value of the inventory are intended to prevent the inventory from being reported at an amount in excess of the net realizable value or at an amount less than the net realizable value less a normal profit margin.
The maximum limitation, not to exceed the net realizable value (ceiling) covers obsolete, damaged, or shopworn material and prevents overstatement Of inventories and understatement Of the loss in the current period. The minimum limitation deters understatement of inventory and overstatement Of the loss in the current period. 3. The usual basis for carrying forward the inventory to the next period is cost. Departure from cost is required when the utility of the goods included in the inventory is less than their cost.
This loss in utility should be recognized as a loss of the current period, the period in which it occurred. Furthermore, the subsequent period should be charged for goods at an amount that measures their expected contribution to that period. In other words, the subsequent period should be charged for inventory at prices no higher than those which would have been paid if the inventory had been obtained at the beginning of that period. Historically, the lower-of-cost-or-market rule arose from the accounting convention of providing tort all losses and anticipating no profits. ) In accordance with the tottering reasoning, the rule of cost or market, whichever is lower may be applied to each item in the inventory, to the total of the components of each major category, or to the total of the inventory, whichever most clearly reflects operations.
The rule is usually applied to each item, but if individual inventory items enter into the same category or categories of finished product, alternative procedures are eatable. The arguments against the use of the lower-of-cost-or-market method of valuing inventories include the following (a) The method requires the reporting of estimated losses (all or a portion of the excess of actual cost over replacement cost) as definite income charges even though the losses hue not been sustained to date and may never be sustained. Ender a consistent criterion of realization a drop in replacement cost below original cost is no more a sustained loss than a rise above cost is a realized gain. (b) A price shrinkage is brought into the income statement before the loss has been sustained through sale. Furthermore, if the charge for the inventor/ write-clowns is not made to a special loss account, the cost figure for goods actually sold is inflated by the amount of the estimated shrinkage in price of the unsold goods. The title Cost of Goods Sold therefore becomes a misnomer. C) The method is inconsistent in application in a given year because it recognizes the propriety of implied price reductions but gives no recognition in the accounts or financial statements to the effect of the price increases. (d) The method is also inconsistent in application in one year as opposed to another because the inventory of a company may be allude at cost in one year and at market in the next year, (e)The lower-of-cost-or- market method values the inventory in the balance sheet conservatively.
Its effect on the income statement, however, may be the opposite. Although the income statement for the year in which the unstained loss is taken is stated conservatively, the net income on the income statement of the subsequent period may be distorted if the expected reductions in sales prices do not materialize, Questions Chapter 9 (Continued) (f] In the application of the lower- of-cost-or-market rule a prospective normal profit is used in determining inventory values in certain cases.
Since normal profit is an estimated figure based upon past experiences (and might not be attained in the future), it is not objective in nature and presents an opportunity for manipulation Of the results of operations. 4. The lower-of-cost-or-market rule may be applied directly to each item or to the total Of the inventory (or in some cases, to the total Of the components of each major category). The method should be the one that most clearly reflects income. The most common practice is to price the inventory on an item-by-item basis. Companies favor the individual item approach because tax acquirement require that an individual. Tem basis be used unless it involves practical difficulties. In addition, the individual item approach gives the most conservative valuation for balance sheet purposes. S. (1) 14. 50. (2) 16. 10. (3) 13. 75. (4) 9. 70. (5) 15. 90, 6. One approach is to record the inventory at cost and then reduce it to market, thereby reflecting a loss in the current period (often referred to as the loss method). The loss would then be shown as a separate item in the income statement and the cost of goods sold for the year would not be distorted by its inclusion.
An objection to this method of valuation is that an inconsistency is created between the income statement and balance sheet, In attempting to meet this inconsistency some have advocated the use of a special account to receive the credit for such an inventory write-down, such as Allowance to Reduce Inventory to Market which is a contra account against inventory on the balance sheet. It should be noted that the disposition of this account presents problems to Another approach is merely to substitute market for cost when pricing the new inventory (often referred to as the cost-of-goods-sold method).
Such a procedure increases cost of goods sold by the amount of the loss and fails to reflect this loss separately. For this reason, many theoretical objections can be raised against this procedure. I An exception to the normal recognition rule occurs where (1) there is a controlled market vita a quoted price applicable to specific commodities and (2) no significant costs Of disposal are involved. Certain agricultural products and precious metals which are immediately marketable at quoted prices are Often valued at net realizable value (market price). 8.
Relative sales value is an appropriate basis for pricing inventory when a group Of varying units is purchased at a single lump-sum price (basket purchase). The purchase price must be allocated in some manner or on some basis among the various units. When the units vary in size, character, and attractiveness, the basis for allocation must reflect both quantitative and qualitative aspects. A suitable basis then is the relative sales value of the units that comprise the inventory. 9. The drop in the market price of the commitment should be charged to operations in the current year if it is material in amount. The following entry would be made (6. 0 5. 0) X 150,000 45,000 unrealized Holding Gain or Looseness (Purchase Commitments) 45,000 Estimated Liability on purchase Commitments 45,000 The entry is made because a 1055 in utility has occurred during the period in which the market decline took place. The account credited in the above entry should be included among the current liabilities on the balance sheet with an appropriate note indicating the nature and extent of the commitment, This liability indicates the minimum obligation on the commitment contract at the present time amount that would have to be forfeited in case of breach of contract.
Questions Chapter g (Continued) 10. The major uses of the gross profit method are (1) it provides an approximation of the ending inventory which the auditor might use for testing validity Of physical inventory count (2) it means that a physical count need not be taken every month or quarter and (3) it helps in determining damages caused by casualty when inventory cannot be counted.