Question & Answer

Reed Pentak, a finance major, has been following globalization and made the following observation concerning accounting convergence: “I do not see many obstacles concerning development of a single accounting standard for inventories.” Prepare a response to Reed to explain the main obstacle to achieving convergence in the area of inventory accounting.

LaTour Inc. is based in France and prepares its financial statements in accordance with IFRS. In

2014, it reported cost of goods sold of $578 million and average inventory of $154 million. Briefly discuss how analysis of LaTour’s inventory turnover (and comparisons to a company using GAAP) might be affected by differences in inventory accounting between IFRS and GAAP.

Briefly describe some of the similarities and differences between GAAP and IFRS with respect to the accounting for inventories.

Jones Co. is in a technology-intensive industry. Recently, one of its competitors introduced a new product with technology that might render obsolete some of Jones’s inventory. The accounting staff wants to follow the appropriate authoritative literature in determining the accounting for this significant market event.

Instructions

If your school has a subscription to the FASB Codification, go to http://aaahg.org/asclogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses.

(a) Identify the primary authoritative guidance for the accounting for inventories. What is the predecessor literature?

(b) List three types of goods that are classified as inventory. What characteristic will automatically exclude an item from being classified as inventory?

(c) Define “market” as used in the phrase “lower-of-cost-or-market.”

(d) Explain when it is acceptable to state inventory above cost and which industries allow this practice.

The financial statements of P&G are presented in Appendix 5B. The company’s complete annual report, including the notes to the financial statements, can be accessed at the book’s companion website, www.

wiley.com/college/kieso.

Instructions

Refer to P&G’s financial statements and the accompanying notes to answer the following questions.

(a) How does P&G value its inventories? Which inventory costing method does P&G use as a basis for reporting its inventories?

(b) How does P&G report its inventories in the balance sheet? In the notes to its financial statements, what three descriptions are used to classify its inventories?

(c) What costs does P&G include in Inventory and Cost of Products Sold?

(d) What was P&G’s inventory turnover in 2011? What is its gross profit percentage? Evaluate P&G’s inventory turnover and its gross profit percentage.

Prophet Company signed a long-term purchase contract to buy timber from the U.S. Forest Service at $300 per thousand board feet. Under these terms, Prophet must cut and pay $6,000,000 for this timber during the next year. Currently, the market value is $250 per thousand board feet.

At this rate, the market price is $5,000,000. Jerry Herman, the controller, wants to recognize the loss in value on the year-end financial statements, but the financial vice president, Billie Hands, argues that the loss is temporary and should be ignored. Herman notes that market value has remained near $250 for many months, and he sees no sign of significant change.

Instructions

(a) What are the ethical issues, if any?

(b) Is any particular stakeholder harmed by the financial vice president’s decision?

(c) What should the controller do?

Olson Corporation, a retailer and wholesaler of national brand-name household lighting fixtures, purchases its inventories from various suppliers.

Instructions

(a) (1) What criteria should be used to determine which of Olson’s costs are inventoriable?

(2) Are Olson’s administrative costs inventoriable? Defend your answer.

(b) (1) Olson uses the lower-of-cost-or-market rule for its wholesale inventories. What are the theoretical arguments for that rule?

(2) The replacement cost of the inventories is below the net realizable value less a normal profit margin, which, in turn, is below the original cost. What amount should be used to value the inventories? Why?

(c) Olson calculates the estimated cost of its ending inventories held for sale at retail using the conventional retail inventory method. How would Olson treat the beginning inventories and net markdowns in calculating the cost ratio used to determine its ending inventories? Why?

Saurez Company, your client, manufactures paint. The company’s president, Maria Saurez, has decided to open a retail store to sell Saurez paint as well as wallpaper and other supplies that would be purchased from other suppliers. She has asked you for information about the conventional retail method of pricing inventories at the retail store.

Instructions

Prepare a report to the president explaining the retail method of pricing inventories. Your report should include the following points.

(a) Description and accounting features of the method.

(b) The conditions that may distort the results under the method.

(c) A comparison of the advantages of using the retail method with those of using cost methods of inventory pricing.

(d) The accounting theory underlying the treatment of net markdowns and net markups under the method.

Ogala Corporation purchased a significant amount of raw materials inventory for a new product that it is manufacturing. Ogala uses the lower-of-cost-or-market rule for these raw materials. The replacement cost of the raw materials is above the net realizable value, and both are below the original cost.

Ogala uses the average-cost inventory method for these raw materials. In the last 2 years, each purchase has been at a lower price than the previous purchase, and the ending inventory quantity for each period has been higher than the beginning inventory quantity for that period.

Instructions

(a) (1) At which amount should Ogala’s raw materials inventory be reported on the balance sheet?

Why?

(2) In general, why is the lower-of-cost-or-market rule used to report inventory?

(b) What would have been the effect on ending inventory and cost of goods sold had Ogala used the LIFO inventory method instead of the average-cost inventory method for the raw materials?

Why?

The market value of Lake Corporation’s inventory has declined below its cost. Sheryl Conan, the controller, wants to use the loss method to write down inventory because it more clearly discloses the decline in market value and does not distort the cost of goods sold. Her supervisor, financial vice president Dick Wright, prefers the cost-of-goods-sold method to write down inventory because it does not call attention to the decline in market value.

Instructions

Answer the following questions.

(a) What, if any, is the ethical issue involved?

(b) Is any stakeholder harmed if Dick Wright’s preference is used?

(c) What should Sheryl Conan do?

You have been asked by the financial vice president to develop a short presentation on the lower-of-cost-or-market method for inventory purposes. The financial VP needs to explain this method to the president because it appears that a portion of the company’s inventory has declined in value.

Instructions

The financial VP asks you to answer the following questions.

(a) What is the purpose of the lower-of-cost-or-market method?

(b) What is meant by “market”? (Hint: Discuss the ceiling and floor constraints.)

(c) Do you apply the lower-of-cost-or-market method to each individual item, to a category, or to the total of the inventory? Explain.

(d) What are the potential disadvantages of the lower-of-cost-or-market method?

Davenport Department Store converted from the conventional retail method to the LIFO retail method on January 1, 2014, and is now considering converting to the dollar-value LIFO inventory method. During your examination of the financial statements for the year ended December 31, 2015, management requested that you furnish a summary showing certain computations of inventory cost for the past 3 years.

Here is the available information.

1. The inventory at January 1, 2013, had a retail value of $56,000 and cost of $29,800 based on the conventional retail method.

2. Transactions during 2013 were as follows.

Cost Retail

Purchases $311,000 $554,000

Purchase returns 5,200 10,000

Purchase discounts 6,000

Gross sales revenue (after employee discounts) 551,000

Sales returns 9,000

Employee discounts 3,000

Freight-in 17,600

Net markups 20,000

Net markdowns 12,000

3. The retail value of the December 31, 2014, inventory was $75,600, the cost ratio for 2014 under the

LIFO retail method was 61%, and the regional price index was 105% of the January 1, 2014, price level.

4. The retail value of the December 31, 2015, inventory was $62,640, the cost ratio for 2015 under the

LIFO retail method was 60%, and the regional price index was 108% of the January 1, 2014, price level.

Instructions

(a) Prepare a schedule showing the computation of the cost of inventory on hand at December 31, 2013, based on the conventional retail method.

(b) Prepare a schedule showing the recomputation of the inventory to be reported on December 31,

2013, in accordance with procedures necessary to convert from the conventional retail method to the LIFO retail method beginning January 1, 2014. Assume that the retail value of the December 31,

2013, inventory was $60,000.

(c) Without prejudice to your solution to part (b), assume that you computed the December 31, 2013, inventory (retail value $60,000) under the LIFO retail method at a cost of $33,300. Prepare a schedule showing the computations of the cost of the store’s 2014 and 2015 year-end inventories under the dollar-value LIFO method.

Diderot Stores Inc., which uses the conventional retail inventory method, wishes to change to the LIFO retail method beginning with the accounting year ending December 31, 2014.

Amounts as shown below appear on the store’s books before adjustment.

Cost Retail

Inventory, January 1, 2014 $ 15,800 $ 24,000

Purchases in 2014 116,200 184,000

Markups in 2014 12,000

Markdowns in 2014 5,500

Sales revenue in 2014 175,000

You are to assume that all markups and markdowns apply to 2014 purchases, and that it is appropriate to treat the entire inventory as a single department.

Instructions

Compute the inventory at December 31, 2014, under the following methods.

(a) The conventional retail method.

(b) The last-in, first-out retail method, effecting the change in method as of January 1, 2014. Assume that the cost-to-retail percentage for 2013 was recomputed correctly in accordance with procedures necessary to change to LIFO. This ratio was 59%.

Late in 2011, Joan Seceda and four other investors took the chain of Becker Department Stores private, and the company has just completed its third year of operations under the ownership of the investment group. Andrea Selig, controller of Becker Department Stores, is in the process of preparing the year-end financial statements. Based on the preliminary financial statements, Seceda has expressed concern over inventory shortages, and she has asked Selig to determine whether an abnormal amount of theft and breakage has occurred. The accounting records of Becker

Department Stores contain the following amounts on November 30, 2014, the end of the fiscal year.

Cost Retail

Beginning inventory $ 68,000 $100,000

Purchases 255,000 400,000

Net markups 50,000

Net markdowns 110,000

Sales revenue 320,000

According to the November 30, 2014, physical inventory, the actual inventory at retail is $115,000.

Instructions

(a) Describe the circumstances under which the retail inventory method would be applied and the advantages of using the retail inventory method.

(b) Assuming that prices have been stable, calculate the value, at cost, of Becker Department Stores’ ending inventory using the last-in, first-out (LIFO) retail method. Be sure to furnish supporting calculations.

(c) Estimate the amount of shortage, at retail, that has occurred at Becker Department Stores during the year ended November 30, 2014.

(d) Complications in the retail method can be caused by such items as (1) freight-in costs, (2) purchase returns and allowances, (3) sales returns and allowances, and (4) employee discounts. Explain how each of these four special items is handled in the retail inventory method.

As of January 1, 2014, Aristotle Inc. installed the retail method of accounting for its merchandise inventory. To prepare the store’s financial statements at June 30, 2014, you obtain the following data.

Cost Selling Price

Inventory, January 1 $ 30,000 $ 43,000

Markdowns 10,500

Markups 9,200

Markdown cancellations 6,500

Markup cancellations 3,200

Purchases 104,800 155,000

Sales revenue 154,000

Purchase returns 2,800 4,000

Sales returns and allowances 8,000

Instructions

(a) Prepare a schedule to compute Aristotle’s June 30, 2014, inventory under the conventional retail method of accounting for inventories.

(b) Without prejudice to your solution to part (a), assume that you computed the June 30, 2014, inventory to be $59,400 at retail and the ratio of cost to retail to be 70%. The general price level has increased from 100 at January 1, 2014, to 108 at June 30, 2014. Prepare a schedule to compute the June 30, 2014, inventory at the June 30 price level under the dollar-value LIFO retail method.

Fiedler Co. follows the practice of valuing its inventory at the lower-of-cost-or-market. The following information is available from the company’s inventory records as of December 31, 2014

Item Quantity

Unit

Cost

Replacement

Cost/Unit

Estimated

Selling

Price/Unit

Completion

& Disposal

Cost/Unit

Normal

Profit

Margin/Unit

A 1,100 $7.50 $8.40 $10.50 $1.50 $1.80

B 800 8.20 7.90 9.40 0.90 1.20

C 1,000 5.60 5.40 7.20 1.15 0.60

D 1,000 3.80 4.20 6.30 0.80 1.50

E 1,400 6.40 6.30 6.70 0.70 1.00

Instructions

Greg Forda is an accounting clerk in the accounting department of Fiedler Co., and he cannot understand why the market value keeps changing from replacement cost to net realizable value to something that he cannot even figure out. Greg is very confused, and he is the one who records inventory purchases and calculates ending inventory. You are the manager of the department and an accountant.

(a) Calculate the lower-of-cost-or-market using the “individual item” approach.

(b) Show the journal entry he will need to make in order to write down the ending inventory from cost to market.

(c) Then write a memo to Greg explaining what designated market value is as well as how it is computed.

Use your calculations to aid in your explanation.

Maddox Specialty Company, a division of Lost World Inc., manufactures three models of gear shift components for bicycles that are sold to bicycle manufacturers, retailers, and catalog outlets. Since beginning operations in 1990, Maddox has used normal absorption costing and has assumed a first-in, first-out cost flow in its perpetual inventory system. The balances of the inventory accounts at the end of Maddox’s fiscal year, November 30, 2014, are shown below. The inventories are stated at cost before any year-end adjustments.

Finished goods $647,000

Work in process 112,500

Raw materials 264,000

Factory supplies 69,000

The following information relates to Maddox’s inventory and operations.

1. The finished goods inventory consists of the items analyzed below.

2. One-half of the head tube shifter finished goods inventory is held by catalog outlets on consignment.

3. Three-quarters of the bar end shifter finished goods inventory has been pledged as collateral for a bank loan.

4. One-half of the raw materials balance represents derailleurs acquired at a contracted price 20% above the current market price. The market value of the rest of the raw materials is $127,400.

5. The total market value of the work in process inventory is $108,700.

6. Included in the cost of factory supplies are obsolete items with an historical cost of $4,200. The market value of the remaining factory supplies is $65,900.

7. Maddox applies the lower-of-cost-or-market method to each of the three types of shifters in finished goods inventory. For each of the other three inventory accounts, Maddox applies the lower-of-costor- market method to the total of each inventory account.

8. Consider all amounts presented above to be material in relation to Maddox’s financial statements taken as a whole.

Instructions

(a) Prepare the inventory section of Maddox’s balance sheet as of November 30, 2014, including any required note(s).

(b) Without prejudice to your answer to (a), assume that the market value of Maddox’s inventories is less than cost. Explain how this decline would be presented in Maddox’s income statement for the fiscal year ended November 30, 2014.

Cost Market

Down tube shifter

Standard model $ 67,500 $ 67,000

Click adjustment model 94,500 89,000

Deluxe model 108,000 110,000

Total down tube shifters 270,000 266,000

Bar end shifter

Standard model 83,000 90,050

Click adjustment model 99,000 97,550

Total bar end shifters 182,000 187,600

Head tube shifter

Standard model 78,000 77,650

Click adjustment model 117,000 119,300

Total head tube shifters 195,000 196,950

Total fi nished goods $647,000 $650,550

(c) Assume that Maddox has a firm purchase commitment for the same type of derailleur included in the raw materials inventory as of November 30, 2014, and that the purchase commitment is at a contracted price 15% greater than the current market price. These derailleurs are to be delivered to

Maddox after November 30, 2014. Discuss the impact, if any, that this purchase commitment would have on Maddox’s financial statements prepared for the fiscal year ended November 30, 2014.

Fuque Inc. uses the retail inventory method to estimate ending inventory for its monthly financial statements. The following data pertain to a single department for the month of

October 2015.

Inventory, October 1, 2015

At cost $ 52,000

At retail 78,000

Purchases (exclusive of freight and returns)

At cost 272,000

At retail 423,000

Freight-in 16,600

Purchase returns

At cost 5,600

At retail 8,000

Markups 9,000

Markup cancellations 2,000

Markdowns (net) 3,600

Normal spoilage and breakage 10,000

Sales revenue 390,000

Instructions

(a) Using the conventional retail method, prepare a schedule computing estimated lower-of-cost-ormarket inventory for October 31, 2015.

(b) A department store using the conventional retail inventory method estimates the cost of its ending inventory as $60,000. An accurate physical count reveals only $47,000 of inventory at lower-of-costor- market. List the factors that may have caused the difference between the computed inventory and the physical count.

Presented below is information related to Waveland Inc.

Cost Retail

Inventory, 12/31/14 $250,000 $ 390,000

Purchases 914,500 1,460,000

Purchase returns 60,000 80,000

Purchase discounts 18,000 —

Gross sales revenue (after employee discounts) — 1,410,000

Sales returns — 97,500

Markups — 120,000

Markup cancellations — 40,000

Markdowns — 45,000

Markdown cancellations — 20,000

Freight-in 42,000 —

Employee discounts granted — 8,000

Loss from breakage (normal) — 4,500

Instructions

Assuming that Waveland Inc. uses the conventional retail inventory method, compute the cost of its ending inventory at December 31, 2015.

The records for the Clothing Department of Sharapova’s Discount Store

are summarized below for the month of January.

Inventory, January 1: at retail $25,000; at cost $17,000

Purchases in January: at retail $137,000; at cost $82,500

Freight-in: $7,000

Purchase returns: at retail $3,000; at cost $2,300

Transfers in from suburban branch: at retail $13,000; at cost $9,200

Net markups: $8,000

Net markdowns: $4,000

Inventory losses due to normal breakage, etc.: at retail $400

Sales revenue at retail: $95,000

Sales returns: $2,400

Instructions

(a) Compute the inventory for this department as of January 31, at retail prices.

(b) Compute the ending inventory using lower-of-average-cost-or-market.

On April 15, 2015, fire damaged the office and warehouse of Stanislaw Corporation. The only accounting record saved was the general ledger, from which the trial balance below was prepared.

The following data and information have been gathered.

1. The fiscal year of the corporation ends on December 31.

2. An examination of the April bank statement and canceled checks revealed that checks written during the period April 1–15 totaled $13,000: $5,700 paid to accounts payable as of March 31, $3,400 for April merchandise shipments, and $3,900 paid for other expenses. Deposits during the same period amounted to $12,950, which consisted of receipts on account from customers with the exception of a $950 refund from a vendor for merchandise returned in April.

3. Correspondence with suppliers revealed unrecorded obligations at April 15 of $15,600 for April merchandise shipments, including $2,300 for shipments in transit (f.o.b. shipping point) on that date.

4. Customers acknowledged indebtedness of $46,000 at April 15, 2015. It was also estimated that customers owed another $8,000 that will never be acknowledged or recovered. Of the acknowledged indebtedness, $600 will probably be uncollectible.

5. The companies insuring the inventory agreed that the corporation’s fire-loss claim should be based on the assumption that the overall gross profit rate for the past 2 years was in effect during the current year. The corporation’s audited financial statements disclosed this information:

Year Ended

December 31

2014 2013

Net sales $530,000 $390,000

Net purchases 280,000 235,000

Beginning inventory 50,000 66,000

Ending inventory 75,000 50,000

Inventory with a cost of $7,000 was salvaged and sold for $3,500. The balance of the inventory wasm a total loss.

Instructions

Prepare a schedule computing the amount of inventory fire loss. The supporting schedule of the computation of the gross profit should be in good form.

Eastman Company lost most of its inventory in a fire in December just before the year-end physical inventory was taken. Corporate records disclose the following.

Inventory (beginning) $ 80,000 Sales revenue $415,000

Purchases 290,000 Sales returns 21,000

Purchase returns 28,000 Gross profi t % based on net selling price 35%

Merchandise with a selling price of $30,000 remained undamaged after the fire, and damaged merchandise has a net realizable value of $8,150. The company does not carry fire insurance on its inventory.

Instructions

Prepare a formal labeled schedule computing the fire loss incurred. (Do not use the retail inventory method.)

Malone Company determined its ending inventory at cost and at lower-of-cost-or-market at December 31, 2013, December 31, 2014, and December 31, 2015, as shown below.

Cost Lower-of-Cost-or-Market

12/31/13 $650,000 $650,000

12/31/14 780,000 712,000

12/31/15 905,000 830,000

Instructions

(a) Prepare the journal entries required at December 31, 2014, and at December 31, 2015, assuming that the cost-of-goods-sold method of adjusting to lower-of-cost-or-market is used.

(b) Prepare the journal entries required at December 31, 2014, and at December 31, 2015, assuming that the loss method of adjusting to lower-of-cost-or-market is used.

Garcia Home Improvement Company installs replacement siding, windows, and louvered glass doors for single-family homes and condominium complexes in northern New Jersey and southern New York. The company is in the process of preparing its annual financial statements for the fiscal year ended May 31, 2014, and Jim Alcide, controller for Garcia, has gathered the following data concerning inventory.

At May 31, 2014, the balance in Garcia’s Raw Materials Inventory account was $408,000, and Allowance to Reduce Inventory to Market had a credit balance of $27,500. Alcide summarized the relevant inventory cost and market data at May 31, 2014, in the schedule below.

Alcide assigned Patricia Devereaux, an intern from a local college, the task of calculating the amount that should appear on Garcia’s May 31, 2014, financial statements for inventory under the lower-of-costor- market rule as applied to each item in inventory. Devereaux expressed concern over departing from the historical cost principle.

Cost

Replacement

Cost

Sales

Price

Net Realizable

Value

Normal

Profit

Aluminum siding $ 70,000 $ 62,500 $ 64,000 $ 56,000 $ 5,100

Cedar shake siding 86,000 79,400 94,000 84,800 7,400

Louvered glass doors 112,000 124,000 186,400 168,300 18,500

Thermal windows 140,000 126,000 154,800 140,000 15,400

Total $408,000 $391,900 $499,200 $449,100 $46,400

Instructions

(a) (1) Determine the proper balance in Allowance to Reduce Inventory to Market at May 31, 2014.

(2) For the fiscal year ended May 31, 2014, determine the amount of the gain or loss that would be recorded due to the change in Allowance to Reduce Inventory to Market.

(b) Explain the rationale for the use of the lower-of-cost-or-market rule as it applies to inventories.

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, 2014, the following finished desks appear in the company’s inventory.

Finished Desks A B C D

2014 catalog selling price $450 $480 $900 $1,050

FIFO cost per inventory list 12/31/14 470 450 830 960

Estimated current cost to manufacture (at December 31, 2014, and early 2015)

460 430 610 1,000

Sales commissions and estimated other costs of disposal 50 60 80 130

2015 catalog selling price 500 540 900 1,200

The 2014 catalog was in effect through November 2014, and the 2015 catalog is effective as of December 1, 2014. All catalog prices are net of the usual discounts. Generally, the company attempts to obtain a 20% gross profit on selling price and has usually been successful in doing so.

Instructions

At what amount should each of the four desks appear in the company’s December 31, 2014, inventory,

assuming that the company has adopted a lower-of-FIFO-cost-or-market approach for valuation of inventories on an individual-item basis?