AFM101 Chapter Notes - Chapter 8: Inventory Turnover, Write-Off

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lilacmouse857

7 Jun 2018

School

University of Waterloo

Department

Accounting & Financial Management

Course

AFM101

Professor

Donna Psutka

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 Net Realizable Value = the expected sales price less [-] estimated selling cost.

o The MARKET VALUE refers to the net realizable value of the inventory.

 Lower of Cost and Net Realizable Value (LCNRV) = valuation method departing from

the cost principle; it serves to recognize a loss when the net realizable value drops below

cost.

o The VALUATION RULE.

 If the market value is less than the cost  write the inventory down.

 Important for 2 types of companies:

o 1) High-tech that manufacture goods for which the cost of production and the

selling price are declining

o 2) Companies that sell seasonal goods (ex: clothing), the value for which drops

dramatically at the end of each selling season.

 LCNRV  companies recognized a loss in the period in which the net realizable value

of an item DROPS rather than in the period in which the item is sold.

o LOSS = difference between the purchase cost and the net realizable value and is

added to the COS of the period.

 Account: Allowance for write-down of inventory to NVR (XA).

 Adjustment: increases COS, decreases NE & decreases reported inventory.

LO6 Evaluate inventory management by using the inventory turnover ratio and the effect of

inventory on Cash Flows.

Inventory Turnover Ratio

 Question: How efficient are inventory management activities?

 Inventory Turnover Ratio = Cost of Sales / Average Inventory.

 Reflects how many time the average inventory was produced and sold during the period.

 Higher ratio = inventory moves more quickly through the production process to the

ultimate consumer; reducing storage and obsolescence costs.

 Average Days to Sell Inventory = 365 / Inventory Turnover Ratio.

 Cautions: Differences across industries in purchasing, production and sales processes cause

dramatic differences in the ratio.

Inventory and Cash Flows

 Decrease in inventory  cost of sales > cost of goods purchased.

o Decrease in inventory must be ADDED to net earning to reflect cost of goods

purchased.

 Increase in inventory  cost of goods purchased > cost of sales.

o Increase in inventory must be SUBTRACTED from net earnings to reflect the cost

of goods purchased.

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Net realizable value = the expected sales price less [-] estimated selling cost: the market value refers to the net realizable value of the inventory. Lower of cost and net realizable value (lcnrv) = valuation method departing from the cost principle; it serves to recognize a loss when the net realizable value drops below cost: the valuation rule. If the market value is less than the cost write the inventory down. Account: allowance for write-down of inventory to nvr (xa). Adjustment: increases cos, decreases ne & decreases reported inventory. Lo6 evaluate inventory management by using the inventory turnover ratio and the effect of inventory on cash flows. Inventory turnover ratio = cost of sales / average inventory. Reflects how many time the average inventory was produced and sold during the period. Higher ratio = inventory moves more quickly through the production process to the ultimate consumer; reducing storage and obsolescence costs.

Related Questions

17 Under lower of cost and market, businesses recognize a holding loss: a. In the period in which the item is actually sold b. In the period in which the item's net realizable value drops below its purchase price C. In the period in which the item is expected to be sold d. In the period in which the item's purchase cost drops below its net realizable value e. None of the above The correct answer is 'b'.

1. How should the balances of Progress Billings and Constructionin Progress be shown at reporting dates prior to completion of along-term contract

a. Progress billings as income, construciton in progress asinventory

b. Net , as income from construction if credit balance, and lossfrom construction if debit balance

c. Progress Billings as deferred income, Construction inProgress as a current asset

d. Net, as a current asset if debit balance and currentliability if credit balance

3. the competed-contract method of accounting for long-termconstruction-type contracts is preferable when

a. a contractor is involved in numerous projects

b. the contracts are of a relatively long duration

c. estimates of costs to complete and extent of progress towardcompletion are reasonably dependable

d. there are inherent uncertainties in the contract beyondnormal business risks

4. C & J Construction has consistently used the percentageof completion method of recognizing income. Last year C & Jstarted work on a $4,500,000 constuction contract, which wascompleted this year, the accounting records desclosed the followingdata for the last year

Progress billings - $1,650,000

Costs incurred - 1,350,000

Collections - 1,050,000

Estimated cost to complete - 2,700,000

How much income should C & J have recognized on thiscontract last year?

a. 105,000

b. 150,000

c. 300,000

d. 350,000

6. The use of the gross profit assumes

a. the amount of gross profit is the same as in prior years

b. sales and cost of goods sold have not changed from previousyears

c. inventory values have not increased from previous years

d. the relationship between selling price and cost of goods soldis similar to prior years

7. the gross profit method of inventory valuation is not validwhen

a. there is substantial increase in the quantity of inventoryduring the year

b. there is substantial increase in the cost of inventory duringthe year

c. the gross margin percentage changes significantly during theyear

d. all ending inventory is destroyed by dire before it can becounted

8. When the current year's ending inventory amount isoverstated,

a. the current year's cost of goods sold is overstated

b. the current year's total assets are understated

c. the current year's net income is overstated

d. the next year's income is overstated

9. If the ending inventory balance is understated, net income ofthe same period

a. will be overstated

b. will be understated

c. will be unaffected

d. cannot be determined from the above information

10. An overstatement of ending inventory in Period 1 wouldresult in income of Period 2 being

a. overstated

b. understated

c. correctly stated

d. the answer cannot be determined from the informationgiven

11. what is the maximum amount at which inventory can be valuedwhen the goods have experienced a permanent decline in value

a. historical cost

b. sales price

c. net realizable value

d. net realizable value reduced by a normal profit margin

12. Net realizable value can be defined as

a. selling price

b. selling price less costs to complete and sell

c. selling price plus costs to complete and sell

d. acquisition cost plus costs to complete and sell

13. Miller company needs an estimate of its ending inventorybalance. The following information is available

Cost Retail

sales revenue - 180,000

beginning inventory - 35,000 62,000

net purchases - 100,000 135,000

gross margin percentage - 30%

Given this information, when using the gross margin estimationmethod, ending inventory is approx

a. 1,000

b. 9,000

c. 19,000

d. 11,650

14. Which of the following would not be reported asinventory?

a. land acquired for resale by a real estate firm

b. stocks and bonds held for resale by a brokerage firm

c. partially completed goods held by a manufacturing company

d. machinery acquired by a manufacturing company for use in theproduction process

15. Cost of goods sold is equal to

a. the cost of inventory on hand at the end of a period plus netpurchases minus the cost of inventory on hand at the beginning

b. the cost of inventory on hand at the beginning of a periodminus net purchases plus the cost of inventory on hand at the endof a period

c. the cost of inventory on hand at the beginning of a periodplus net sales minus the cost of inventory on hand at the end of aperiod

d. the cost of inventory on hand at the beginning of a periodplus net purchases minus the cost of inventory on hand at the endof a period

17. In a period of falling prices, the use of which of thefolliwng inventory cost flow methods would typically result inhighest cost of goods sold?

a. FIFO

b. LIFO

c. Weighted average cost

d. Specific identification

18. In a period of rising prices, the inventory cost allocationmethod that tends to result in the lowest reported net incomeis

a. LIFO

b. FIFO

c. Moving average

d. Weighted average

19. The LIFO inventory cost flow method may be applied to whichof the following inventory systems?

Periodic Perpetual

a. no no

b. no yes

c. yes yes

d. yes no

tanrabbit20

1-Nash Home Improvement Company installs replacement siding, windows, and louvered glass doors for single-family homes and condominium complexes. The company is in the process of preparing its annual financial statements for the fiscal year ended May 31, 2017. Jim Alcide, controller for Nash, has gathered the following data concerning inventory. At May 31, 2017, the balance in Nashâs Raw Materials Inventory account was $456,960, and Allowance to Reduce Inventory to NRV had a credit balance of $27,660. Alcide summarized the relevant inventory cost and market data at May 31, 2017, in the schedule below. Alcide assigned Patricia Devereaux, an intern from a local college, the task of calculating the amount that should appear on Nashâs May 31, 2017, financial statements for inventory under the LCNRV rule as applied to each item in inventory. Devereaux expressed concern over departing from the historical cost principle. Cost Sales Price Net Realizable Value Aluminum siding $78,400 $71,680 $62,720 Cedar shake siding 96,320 105,280 94,976 Louvered glass doors 125,440 208,768 188,496 Thermal windows 156,800 173,376 156,800 Total $456,960 $559,104 $502,992 -Determine the proper balance in Allowance to Reduce Inventory to NRV at May 31, 2017. Balance in the Allowance to Reduce Inventory to NRV $ and The amount of the gain (loss)$

2-The records for the Clothing Department of Novakâs Discount Store are summarized below for the month of January.

inventory, January 1: at retail $24,600; at cost $17,000

Purchases in January: at retail $138,400; at cost $94,259

Freight-in: $9,100

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

Transfers in from suburban branch: at retail $13,100; at cost $6,900

Net markups: $8,000

Net markdowns: $3,900

Inventory losses due to normal breakage, etc.: at retail $300

Sales revenue at retail: $95,400

Sales returns: $2,400 Compute the inventory for this department as of January 31, at retail prices.

Ending inventory at retail		$
Ending inventory at lower-of-average-cost-or-market

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AFM101 Chapter Notes - Chapter 8: Inventory Turnover, Write-Off

AFM101 Full Course Notes

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