Question & Answer

Under what circumstances is relative sales value an appropriate basis for determining the price assigned to inventory?

What factors might call for inventory valuation at sales prices (net realizable value or market price)?

What method(s) might be used in the accounts to record a loss due to a price decline in the inventories? Discuss.

In some instances, accounting principles require a departure from valuing inventories at cost alone. Determine the proper unit inventory price in the following cases.

Cases

1 2 3 4 5

Cost $15.90 $16.10 $15.90 $15.90 $15.90

Net realizable value 14.50 19.20 15.20 10.40 16.40

Net realizable value less normal profi t 12.80 17.60 13.75 8.80 14.80

Market (replacement cost) 14.80 17.20 12.80 9.70 16.80

What approaches may be employed in applying the lower-of-cost-or-market procedure? Which approach is normally used and why?

Why are inventories valued at the lower-of-cost-ormarket? What are the arguments against the use of the LCM method of valuing inventories?

Explain the rationale for the ceiling and floor in the lowerof- cost-or-market method of valuing inventories.

Where there is evidence that the utility of inventory goods, as part of their disposal in the ordinary course of business, will be less than cost, what is the proper accounting treatment?

reported the following data in its annual report.

Feb. 27, Feb. 26, Feb. 25,

2010 2011 2012

Total revenues $40,597 $37,534 $36,100

Cost of sales (using LIFO) 31,444 29,124 28,010

Year-end inventories using FIFO 2,606 2,552 2,492

Year-end inventories using LIFO 2,342 2,270 2,150

(a) Compute SUPERVALU’s inventory turnovers for 2011 and 2012, using:

(1) Cost of sales and LIFO inventory.

(2) Cost of sales and FIFO inventory.

(b) Some firms calculate inventory turnover using sales rather than cost of goods sold in the numerator.

Calculate SUPERVALU’s 2011 and 2012 turnover, using:

(1) Sales and LIFO inventory.

(2) Sales and FIFO inventory.

(c) Describe the method that SUPERVALU’s appears to use.

(d) State which method you would choose to evaluate SUPERVALU’s performance. Justify your choice.

Noven Pharmaceuticals, Inc., headquartered in Miami, Florida, describes itself in a recent annual report as follows.

Noven also reported in its annual report that its activities to date have consisted of product development efforts, some of which have been independent and some of which have been completed in conjunction with Rhone-Poulenc Rorer (RPR) and Ciba-Geigy. The revenues so far have consisted of money received from licensing fees, “milestone” payments (payments made under licensing agreements when certain stages of the development of a certain product have been completed), and interest on its investments. The company expects that it will have significant revenue in the upcoming fiscal year from the launch of its first product, a transdermal estrogen delivery system.

The current assets portion of Noven’s balance sheet follows.

Cash and cash equivalents $12,070,272

Securities held to maturity 23,445,070

Inventory of supplies 1,264,553

Prepaid and other current assets 825,159

Total current assets $37,605,054

Inventory of supplies is recorded at the lower-of-cost (first-in, first-out)-or-net realizable value and consists mainly of supplies for research and development.

Instructions

(a) What would you expect the physical flow of goods for a pharmaceutical manufacturer to be most like:

FIFO, LIFO, or random (flow of goods does not follow a set pattern)? Explain.

(b) What are some of the factors that Noven should consider as it selects an inventory measurement method?

(c) Suppose that Noven had $49,000 in an inventory of transdermal estrogen delivery patches. These patches are from an initial production run and will be sold during the coming year. Why do you think that this amount is not shown in a separate inventory account? In which of the accounts shown is the inventory likely to be? At what point will the inventory be transferred to a separate inventory account?

was founded in 1969 as Trus Joist International. The firm, a manufacturer of specialty building products, has its headquarters in Boise, Idaho. The company, through its partnership in the Trus

Joist MacMillan joint venture, develops and manufactures engineered lumber. This product is a high-quality substitute for structural lumber and uses lower-grade wood and materials formerly considered waste. The company also is majority owner of the Outlook Window Partnership, which is a consortium of three wood and vinyl window manufacturers.

Following is T J International’s adapted income statement and information concerning inventories from its annual report.

Instructions

(a) How much would income before taxes have been if FIFO costing had been used to value all inventories?

(b) If the income tax rate is 46.6%, what would income tax have been if FIFO costing had been used to value all inventories? In your opinion, is this difference in net income between the two methods material?

Explain.

(c) Does the use of a different costing system for different types of inventory mean that there is a different physical flow of goods among the different types of inventory? Explain.

conducting year-end inventory counts, your audit team is debating the impact of the client’s right of return policy both on inventory valuation and revenue recognition. The assistant controller argues that there is no need to worry about the return policies since they have not changed in a while. The audit senior wants a more authoritative answer and has asked you to conduct some research of the authoritative literature before she presses the point with the client.

Instructions

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

(a) What is the authoritative guidance for revenue recognition when right of return exists?

(b) When is this guidance important for a company?

(c) Sales with high rates of return can ultimately cause inventory to be misstated. Why are returns allowed? Should different industries be able to make different types of return policies?

(d) In what situations would a reasonable estimate of returns be difficult to make?

Harrisburg Company is considering changing its inventory valuation method from FIFO to LIFO because of the potential tax savings. However, management wishes to consider all of the effects on the company, including its reported performance, before making the final decision.

The inventory account, currently valued on the FIFO basis, consists of 1,000,000 units at $8 per unit on

January 1, 2014. There are 1,000,000 shares of common stock outstanding as of January 1, 2014, and the cash balance is $400,000.

The company has made the following forecasts for the period 2014–2016.

2014 2015 2016

Unit sales (in millions of units) 1.1 1.0 1.3

Sales price per unit $10 $12 $12

Unit purchases (in millions of units) 1.0 1.1 1.2

Purchase price per unit $8 $9 $10

Annual depreciation (in thousands of dollars) $300 $300 $300

Cash dividends per share $0.15 $0.15 $0.15

Cash payments for additions to and replacement of plant and equipment (in thousands of dollars) $350 $350 $350

Income tax rate 40% 40% 40%

Operating expenses (exclusive of depreciation) as a percent of sales 15% 15% 15%

Common shares outstanding (in millions) 1 1 1

Instructions

(a) Prepare a schedule that illustrates and compares the following data for Harrisburg Company under

the FIFO and the LIFO inventory method for 2014–2016. Assume the company would begin LIFO

at the beginning of 2014.

(1) Year-end inventory balances. (3) Earnings per share.

(2) Annual net income after taxes. (4) Cash balance.

Assume all sales are collected in the year of sale and all purchases, operating expenses, and taxes are

paid during the year incurred.

(b) Using the data above, your answer to (a), and any additional issues you believe need to be considered,

prepare a report that recommends whether or not Harrisburg Company should change to the

LIFO inventory method. Support your conclusions with appropriate arguments.

Arruza Co. is considering switching from the specific-goods LIFO approach to the dollar-value LIFO approach. Because the financial personnel at Arruza know very little about dollar-value LIFO, they ask you to answer the following questions.

(a) What is a LIFO pool?

(b) Is it possible to use a LIFO pool concept and not use dollar-value LIFO? Explain.

(c) What is a LIFO liquidation?

(d) How are price indexes used in the dollar-value LIFO method?

(e) What are the advantages of dollar-value LIFO over specific-goods LIFO?

Geddes Corporation is a medium-sized manufacturing companywith two divisions and three subsidiaries, all located in the United States. The Metallic Division manufactures metal castings for the automotive industry, and the Plastic Division produces small plastic items for electrical products and other uses. The three subsidiaries manufacture various products for other industrial users.

Geddes Corporation plans to change from the lower of first-in, first-out (FIFO)-cost-or market method of inventory valuation to the last-in, first-out (LIFO) method of inventory valuation to obtain tax benefits.

To make the method acceptable for tax purposes, the change also will be made for its annual financial statements.

Instructions

(a) Describe the establishment of and subsequent pricing procedures for each of the following LIFO inventory methods.

(1) LIFO applied to units of product when the periodic inventory system is used.

(2) Application of the dollar-value method to LIFO units of product.

(b) Discuss the specific advantages and disadvantages of using the dollar-value LIFO application as compared to specific goods LIFO (unit LIFO). (Ignore income tax considerations.)

(c) Discuss the general advantages and disadvantages claimed for LIFO methods.

Prepare a memorandum containing responses to the following items.

(a) Describe the cost flow assumptions used in average-cost, FIFO, and LIFO methods of inventory valuation.

(b) Distinguish between weighted-average-cost and moving-average-cost for inventory costing purposes.

(c) Identify the effects on both the balance sheet and the income statement of using the LIFO method instead of the FIFO method for inventory costing purposes over a substantial time period when purchase prices of inventoriable items are rising. State why these effects take place.

Jane Yoakam, president of Estefan Co., recently read an article that claimed that at least 100 of the country’s largest 500 companies were either adopting or considering adopting the last-in, first-out (LIFO) method for valuing inventories. The article stated that the firms were switching to LIFO to (1) neutralize the effect of inflation in their financial statements, (2) eliminate inventory profits, and (3) reduce income taxes. Ms. Yoakam wonders if the switch would benefit her company.

Estefan currently uses the first-in, first-out (FIFO) method of inventory valuation in its periodic inventory system. The company has a high inventory turnover rate, and inventories represent a significant proportion of the assets.

Ms. Yoakam has been told that the LIFO system is more costly to operate and will provide little benefit to companies with high turnover. She intends to use the inventory method that is best for the company in the long run rather than selecting a method just because it is the current fad.

Instructions

(a) Explain to Ms. Yoakam what “inventory profits” are and how the LIFO method of inventory valuation could reduce them.

(b) Explain to Ms. Yoakam the conditions that must exist for Estefan Co. to receive tax benefits from a switch to the LIFO method.

In January 2014, Susquehanna Inc. requested and secured permission from the commissioner of the Internal Revenue Service to compute inventories under the last-in, first-out

(LIFO) method and elected to determine inventory cost under the dollar-value LIFO method. Susquehanna

Inc. satisfied the commissioner that cost could be accurately determined by use of an index number computed from a representative sample selected from the company’s single inventory pool.

Instructions

(a) Why should inventories be included in (1) a balance sheet and (2) the computation of net income?

(b) The Internal Revenue Code allows some accountable events to be considered differently for income tax reporting purposes and financial accounting purposes, while other accountable events must be reported the same for both purposes. Discuss why it might be desirable to report some accountable events differently for financial accounting purposes than for income tax reporting purposes.

(c) Discuss the ways and conditions under which the FIFO and LIFO inventory costing methods produce different inventory valuations. Do not discuss procedures for computing inventory cost.

Shawnee Corp., a household appliances dealer, purchases its inventories from various suppliers. Shawnee has consistently stated its inventories at the lower-of-cost (FIFO)-or-market.

Instructions

Shawnee is considering alternate methods of accounting for the cash discounts it takes when paying its suppliers promptly. From a theoretical standpoint, discuss the acceptability of each of the following methods.

(a) Financial income when payments are made.

(b) Reduction of cost of goods sold for the period when payments are made.

(c) Direct reduction of purchase cost.

George Solti, the controller for Garrison Lumber Company, has recently hired you as assistant controller. He wishes to determine your expertise in the area of inventory accounting and therefore asks you to answer the following unrelated questions.

(a) A company is involved in the wholesaling and retailing of automobile tires for foreign cars. Most of the inventory is imported, and it is valued on the company’s records at the actual inventory cost plus freight-in. At year-end, the warehousing costs are prorated over cost of goods sold and ending inventory. Are warehousing costs considered a product cost or a period cost?

(b) A certain portion of a company’s “inventory” is composed of obsolete items. Should obsolete items that are not currently consumed in the production of “goods or services to be available for sale” be classified as part of inventory?

(c) A company purchases airplanes for sale to others. However, until they are sold, the company charters and services the planes. What is the proper way to report these airplanes in the company’s financial statements?

(d) A company wants to buy coal deposits but does not want the financing for the purchase to be reported on its financial statements. The company therefore establishes a trust to acquire the coal deposits. The company agrees to buy the coal over a certain period of time at specified prices. The trust is able to finance the coal purchase and pay off the loan as it is paid by the company for the minerals. How should this transaction be reported?

Brian Erlacher, an inventory control specialist, is interested in better understanding the accounting for inventories. Although Brian understands the more sophisticated computer inventory control systems, he has little knowledge of how inventory cost is determined. In studying the records of Strider Enterprises, which sells normal brand-name goods from its own store and on consignment through Chavez Inc., he asks you to answer the following questions.

Instructions

(a) Should Strider Enterprises include in its inventory normal brand-name goods purchased from its suppliers but not yet received if the terms of purchase are f.o.b. shipping point (manufacturer’s plant)? Why?

(b) Should Strider Enterprises include freight-in expenditures as an inventory cost? Why?

(c) If Strider Enterprises purchases its goods on terms 2/10, net 30, should the purchases be recorded gross or net? Why?

(d) What are products on consignment? How should they be reported in the financial statements?

You are asked to travel to Milwaukee to observe and verify the inventory of the Milwaukee branch of one of your clients. You arrive on Thursday, December 30, and find that the inventory procedures have just been started. You spot a railway car on the sidetrack at the unloading door and ask the warehouse superintendent, Buck Rogers, how he plans to inventory the contents of the car. He responds, “We are not going to include the contents in the inventory.”

Later in the day, you ask the bookkeeper for the invoice on the carload and the related freight bill. The invoice lists the various items, prices, and extensions of the goods in the car. You note that the carload was shipped December 24 from Albuquerque, f.o.b. Albuquerque, and that the total invoice price of the goods in the car was $35,300. The freight bill called for a payment of $1,500. Terms were net 30 days. The bookkeeper affirms the fact that this invoice is to be held for recording in January.

Instructions

(a) Does your client have a liability that should be recorded at December 31? Discuss.

(b) Prepare a journal entry(ies), if required, to reflect any accounting adjustment required. Assume a perpetual inventory system is used by your client.

(c) For what possible reason(s) might your client wish to postpone recording the transaction?

Richardson Company cans a variety of vegetable-type soups. Recently, the company decided to value its inventories using dollar-value LIFO pools. The clerk who accounts for inventories does not understand how to value the inventory pools using this new method, so, as a private consultant, you have been asked to teach him how this new method works. He has provided you with the following information about purchases made over a 6-year period.

Ending Inventory

Date (End-of-Year Prices) Price Index

Dec. 31, 2010 $ 80,000 100

Dec. 31, 2011 111,300 105

Dec. 31, 2012 108,000 120

Dec. 31, 2013 128,700 130

Dec. 31, 2014 147,000 140

Dec. 31, 2015 174,000 145

You have already explained to him how this inventory method is maintained, but he would feel better about it if you were to leave him detailed instructions explaining how these calculations are done and why he needs to put all inventories at a base-year value.

Instructions

(a) Compute the ending inventory for Richardson Company for 2010 through 2015 using dollar-value LIFO.

(b) Using your computation schedules as your illustration, write a step-by-step set of instructions explaining how the calculations are done. Begin your explanation by briefly explaining the theory behind this inventory method, including the purpose of putting all amounts into base-year price levels.

Presented below is information related to Kaisson Corporation for the last 3 years.

Quantities Base-Year Cost Current-Year Cost in Ending Item Inventories Unit Cost Amount Unit Cost Amount

December 31, 2013

A 9,000 $2.00 $18,000 $2.20 $19,800

B 6,000 3.00 18,000 3.55 21,300

C 4,000 5.00 20,000 5.40 21,600

Totals $56,000 $62,700

December 31, 2014

A 9,000 $2.00 $18,000 $2.60 $23,400

B 6,800 3.00 20,400 3.75 25,500

C 6,000 5.00 30,000 6.40 38,400

Totals $68,400 $87,300

December 31, 2015

A 8,000 $2.00 $16,000 $2.70 $21,600

B 8,000 3.00 24,000 4.00 32,000

C 6,000 5.00 30,000 6.20 37,200

Totals $70,000 $90,800

Instructions

Compute the ending inventories under the dollar-value LIFO method for 2013, 2014, and 2015. The base period is January 1, 2013, and the beginning inventory cost at that date was $45,000. Compute indexes to two decimal places.

On January 1, 2014, Bonanza Wholesalers Inc. adopted the dollar-value LIFO inventory method for income tax and external financial reporting purposes. However,

Bonanza continued to use the FIFO inventory method for internal accounting and management purposes.

In applying the LIFO method, Bonanza uses internal conversion price indexes and the multiple pools approach under which substantially identical inventory items are grouped into LIFO inventory pools. The following data were available for inventory pool no. 1, which comprises products A and B, for the 2 years following the adoption of LIFO.

FIFO Basis per Records

Unit Total

Units Cost Cost

Inventory, 1/1/14

Product A 10,000 $30 $300,000

Product B 9,000 25 225,000

$525,000

Inventory, 12/31/14

Product A 17,000 36 $612,000

Product B 9,000 26 234,000

$846,000

Inventory, 12/31/15

Product A 13,000 40 $520,000

Product B 10,000 32 320,000

$840,000

Instructions

(a) Prepare a schedule to compute the internal conversion price indexes for 2014 and 2015. Round indexes to two decimal places.

(b) Prepare a schedule to compute the inventory amounts at December 31, 2014 and 2015, using the dollar-value LIFO inventory method.