CH 09

9-1
PREVIEW OF CHAPTER
Intermediate Accounting
IFRS 2nd Edition
Kieso, Weygandt, and Warfield
9-2
Inventories: Additional
Valuation Issues
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe and apply the lower-ofcost-or-net realizable value rule.
5. Determine ending inventory by applying

the gross profit method.
2. Explain when companies value

inventories at net realizable value.

the retail inventory method.
3. Explain when companies use the

relative standalone sales value method
to value inventories.
7. Explain how to report and analyze

inventory.
4. Discuss accounting issues related to

purchase commitments.
9-3
LOWER-OF-COST-OR-NET REALIZABLE
VALUE (LCNRV)
A company abandons the historical cost principle when
the future utility (revenue-producing ability) of the
asset drops below its original cost.
9-4
LO 1
LCNRV
Net Realizable Value
Estimated selling price in the normal course of business less
9-5
estimated costs to complete and
estimated costs to make a sale.
ILLUSTRATION 9-1
Computation of Net
Realizable Value
LO 1
LCNRV
Net Realizable Value
9-6
ILLUSTRATION 9-2
LCNRV Disclosures
LO 1
LCNRV
ILLUSTRATION 9-3
Determining Final
Inventory Value
Illustration of LCNRV: Jinn-Feng Foods computes its

inventory at LCNRV (amounts in thousands).
9-7
LO 1
LCNRV
Methods of Applying LCNRV
9-8
ILLUSTRATION 9-4
Alternative Applications
of LCNRV
LO 1
LCNRV
Methods of Applying LCNRV
9-9
In most situations, companies price inventory on an itemby-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.
LO 1
Recording Net Realizable Value

Illustration: Data for Ricardo Company
Cost of goods sold (before adj. to NRV)
Ending inventory (cost)
Ending inventory (at NRV)
Loss
Loss
Method
Method
COGS
COGS
Method
Method
9-10
Loss Due to Decline to NRV
108,000
82,000
70,000
12,000
Inventory (82,000 - 70,000)

12,000
Cost of Goods Sold
12,000
Inventory
12,000
LO 1

Partial Statement of Financial Position
9-11
LO 1

Income Statement
9-12
LCNRV
Use of an Allowance
Instead of crediting the Inventory account for net realizable
value adjustments, companies generally use an allowance
account.
Loss
Loss Method
Method
Loss Due to Decline to NRV
Allowance to Reduce Inventory to NRV
9-13
12,000
12,000
LO 1
Use of an Allowance
Partial Statement of Financial Position
9-14
LO 1
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
9-15
4,000
4,000
LO 1

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 9-8
Effect on Net Income of Adjusting
Inventory to Net Realizable Value
9-16
LO 1
Evaluation of LCM 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 occursnot 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.
9-17
LO 1
LCNRV
P9-1: Remmers Company manufactures desks. Most of the
companys desks are standard models and are sold on the basis of
catalog prices. At December 31, 2015, the following finished desks
appear in the companys inventory.
Instructions: At what amount should the desks appear in the

companys 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?
9-18
LO 1
LCNRV
P9-1: Remmers Company manufactures desks. Most of the
companys desks are standard models and are sold on the basis of
catalog prices. At December 31, 2015, the following finished desks
appear in the companys inventory.
9-19
LO 1
Valuation Issues
LEARNING OBJECTIVES
1. Describe and apply the lower-of-cost-ornet realizable value rule.


3. Explain when companies use the relative
standalone sales value method to value
inventories.
9-20

inventory.
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:
9-21
Agricultural assets
Commodities held by broker-traders.
LO 2

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.
9-22
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.
LO 2

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.
9-23
Agricultural produce are measured at fair value less

costs to sell (NRV) at the point of harvest.
Once harvested, the NRV becomes cost.
LO 2
Agricultural Accounting at NRV

Illustration: Bancroft Dairy produces milk for sale to local cheesemakers. Bancroft began operations on January 1, 2015, by
purchasing 420 milking cows for 460,000. Bancroft provides the
ILLUSTRATION 9-9
following information related to the milking cows.
Agricultural Assets
Bancroft Dairy
9-24
LO 2
ILLUSTRATION 9-9
Agricultural Assets
Bancroft Dairy
Bancroft makes the following entry to record the change in

carrying value of the milking cows.
Biological Asset (milking cows)
Unrealized Holding Gain or LossIncome
9-25
33,800
33,800
LO 2

Biological Asset (milking cows)
33,800

33,800
Reported on the Statement of financial position as a noncurrent asset at fair value less costs to sell (net realizable
value).
Reported as Other income and expense on the income

statement.
9-26
LO 2

Illustration: Bancroft makes the following summary entry to
record the milk harvested for the month of January.
Inventory (milk)
36,000
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
Cost of Goods Sold
Inventory (milk)
9-27
38,500
36,000
36,000
LO 2

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.
9-28
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.
LO 2
Valuation Issues
LEARNING OBJECTIVES




relative standalone sales value
method to value inventories.

inventory.

9-29
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.
9-30
LO 3
VALUATION BASES
ILLUSTRATION 9-10
Allocation of Costs,
Using Relative Standalone
Sales Value
ILLUSTRATION 9-11
Determination of Gross Profit,
Using Relative Standalone Sales Value
9-31
LO 3
Valuation Issues
LEARNING OBJECTIVES



3. Explain when companies use the relative

standalone sales value method to value
inventories.

inventory.
4. Discuss accounting issues

related to purchase commitments.
9-32
VALUATION BASES
Purchase CommitmentsA Special Problem
9-33
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.
LO 4
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 LossIncome 3,000,000
Purchase Commitment Liability
3,000,000
Other expenses and losses in the Income statement.

Current liabilities on the balance sheet.
9-34
LO 4
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
Cash
3,000,000
10,000,000
Assume Apres is permitted to reduce its contract price and

therefore its commitment by 1,000,000.
1,000,000

9-35
1,000,000
LO 4
Valuation Issues
LEARNING OBJECTIVES
1. Describe and apply the lower-of-costor-net realizable value rule.
9-36
5. Determine ending inventory by

applying the gross profit
method.
inventory.
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.
9-37
LO 5
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 9-13
Application of Gross Profit Method
9-38
LO 5
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 9-14
Computation of Gross
Profit Percentage
9-39
LO 5
GROSS PROFIT METHOD
Illustration 9-16
Application of
Gross Profit
Formulas
9-40
Illustration 9-15
Formulas Relating
to Gross Profit
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
Purchases (gross)
640,000
Freight-in
30,000
Sales
1,000,000
Sales returns
70,000
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.
9-41
LO 5
GROSS PROFIT METHOD

(a) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of sales.
9-42
LO 5
GROSS PROFIT METHOD

(b) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of cost.
25%
100% + 25%
9-43
= 20% of sales
LO 5
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.
9-44
LO 5
THE SQUEEZE
WHATS
YOUR PRINCIPLE
Managers and analysts closely follow gross
profits. A small change in the gross profit
rate can significantly affect the bottom line.
For example, at one time, Apple Computer
(USA) suffered a textbook case of shrinking
gross profits. In response to pricing wars in
the personal computer market, Apple had
to quickly reduce the price of its signature
Macintosh computersreducing prices
more quickly than it could reduce its costs.
As a result, its gross profit rate fell from 44
percent in 1992 to 40 percent in 1993.
Though the drop of 4 percent seems small,
its impact on the bottom line caused
Apples share price to drop from $57 per
share to $27.50 in just six weeks.
9-45
As another example, Debenham (GBR),

the second largest department store in the
United Kingdom, experienced a 14
percentage share price decline. The
cause? Markdowns on slow-moving
inventory reduced its gross margin. On the
positive side, an increase in the gross profit
rate provides a positive signal to the
market. For example, just a 1 percent boost
in Dr. Peppers (USA) gross profit rate
cheered the market, indicating the
company was able to avoid the squeeze of
increased commodity costs by raising its
prices.
Sources: Alison Smith, Debenhams Shares
Hit by Warning, Financial Times (July 24,
2002), p. 21; and D. Kardous, Higher Pricing
Helps Boost Dr. Pepper Snapples Net, Wall
Street Journal Online (June 5, 2008).
LO 5
Valuation Issues
LEARNING OBJECTIVES


6. Determine ending inventory by

applying the retail inventory
method.

9-46

inventory.
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
9-47
Conventional Method (or LCNRV)
Cost Method
LO 6

Illustration: 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.
9-48
LO 6
9-49
LO 6
9-50
LO 6

Special Items Relating to Retail Method
9-51
Freight costs
Purchase returns
Purchase discounts and allowances
Transfers-in
Normal shortages
Abnormal shortages
Employee discounts
When
When sales
sales are
are recorded
recorded
gross,
gross, companies
companies do
do not
not
recognize
recognize sales
sales discounts.
discounts.
LO 6

Special
Items
ILLUSTRATION 9-22
Conventional Retail
Inventory Method
Special Items Included
9-52
LO 6

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.
9-53
LO 6
Valuation Issues
LEARNING OBJECTIVES




7. Explain how to report and

analyze inventory.

9-54
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.
9-55
LO 7

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.
9-56
LO 7

Analysis of Inventories
Common ratios used in the management and evaluation of
inventory levels are inventory turnover and average days
to sell the inventory.
9-57
LO 7

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 9-25
9-58
LO 7

Average Days to Sell Inventory
Measure represents the average number of days sales for
which a company has inventory on hand.
Illustration 9-25
Average Days to Sell
365 days / 4.30 times = every 84.8 days

9-59
LO 7
GLOBAL ACCOUNTING INSIGHTS

INVENTORIES
In most cases, IFRS and U.S. GAAP related to inventory are the same. The
major differences are that IFRS prohibits the use of the LIFO cost flow
assumption and records market in the LCNRV differently.
9-60

Relevant Facts
Following are the key similarities and differences between U.S. GAAP and
IFRS related to inventories.
Similarities
U.S. GAAP and IFRS account for inventory acquisitions at historical cost
and evaluate inventory for lower-of-cost-or-net realizable value (market)
subsequent to acquisition.
Who owns the goodsgoods in transit, consigned goods, special sales
agreementsas well as the costs to include in inventory are essentially
accounted for the same under U.S. GAAP and IFRS.
9-61

Relevant Facts
Differences
U.S. GAAP provides more detailed guidelines in inventory accounting. The
requirements for accounting for and reporting inventories are more
principles-based under IFRS.
A major difference between U.S. GAAP and IFRS relates to the LIFO cost
flow assumption. U.S. GAAP permits the use of LIFO for inventory
valuation. IFRS prohibits its use. FIFO and average-cost are the only two
acceptable cost flow assumptions permitted under IFRS. Both sets of
standards permit specific identification where appropriate.
9-62

Relevant Facts
Differences
In the lower-of-cost-or-market test for inventory valuation, U.S. GAAP
defines market as replacement cost subject to the constraints of net
realizable value (the ceiling) and net realizable value less a normal markup
(the floor). IFRS defines market as net realizable value and does not use a
ceiling or a floor to determine market.
Under U.S. GAAP, if inventory is written down under the lower-of-cost-ormarket valuation, the new basis is now considered its cost. As a result, the
inventory may not be written up back to its original cost in a subsequent
period. Under IFRS, the write-down may be reversed in a subsequent
period up to the amount of the previous write-down. Both the write-down
and any subsequent reversal should be reported on the income statement.
9-63

Relevant Facts
Differences
IFRS requires both biological assets and agricultural produce at the point of
harvest to be reported at net realizable value. U.S. GAAP does not require
companies to account for all biological assets in the same way.
Furthermore, these assets generally are not reported at net realizable value.
Disclosure requirements also differ between the two sets of standards.
9-64

About The Numbers
Presented below is a disclosure under U.S. GAAP related to inventories,
which reflects application of U.S. GAAP to its inventories.
9-65

On the Horizon
One convergence issue that will be difficult to resolve relates to the use of the
LIFO cost flow assumption. As indicated, IFRS specifically prohibits its use.
Conversely, the LIFO cost flow assumption is widely used in the United States
because of its favorable tax advantages. In addition, many argue that LIFO
from a financial reporting point of view provides a better matching of current
costs against revenue and therefore enables companies to compute a more
realistic income.
9-66
COPYRIGHT
Copyright 2014 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.
9-67

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9-1

1. Describe and apply the lower-ofcost-or-net realizable value rule.

5. Determine ending inventory by applying

2. Explain when companies value

6. Determine ending inventory by applying

3. Explain when companies use the

7. Explain how to report and analyze

4. Discuss accounting issues related to

estimated costs to complete and

estimated costs to make a sale.

Illustration of LCNRV: Jinn-Feng Foods computes its

In most situations, companies price inventory on an itemby-item basis.

Tax rules in some countries require that companies use an

Individual-item approach gives the lowest valuation for

Method should be applied consistently from one period to

Recording Net Realizable Value

Loss Due to Decline to NRV

Inventory (82,000 - 70,000)

Recording Net Realizable Value

Recording Net Realizable Value

Amount of write-down is reversed.

Reversal limited to amount of original write-down.

Continuing the Ricardo example, assume the net realizable

Recovery of Inventory Loss

Evaluation of LCM Rule

Instructions: At what amount should the desks appear in the

5. Determine ending inventory by applying

6. Determine ending inventory by applying

7. Explain how to report and analyze

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:

Commodities held by broker-traders.

Special Valuation Situations

Biological asset (classified as a non-current asset) is a

Biological assets are measured on initial recognition and

Companies record gain or loss due to changes in NRV of

Special Valuation Situations

Agricultural produce is the harvested product of a biological

Agricultural produce are measured at fair value less

Once harvested, the NRV becomes cost.

Agricultural Accounting at NRV

Agricultural Accounting at NRV

Bancroft makes the following entry to record the change in

Agricultural Accounting at NRV

Unrealized Holding Gain or LossIncome

Reported as Other income and expense on the income

Agricultural Accounting at NRV

Unrealized Holding Gain or LossIncome

Assuming the milk harvested in January was sold to a local

Special Valuation Situations

Generally measure their inventories at fair value less costs to

Buy or sell commodities (such as harvested corn, wheat,

sell the commodities in the near term and

generate a profit from fluctuations in price.

5. Determine ending inventory by applying

2. Explain when companies value

6. Determine ending inventory by applying

3. Explain when companies use the

7. Explain how to report and analyze

4. Discuss accounting issues related to

5. Determine ending inventory by applying