Chapter 4 Inventories: Additional Issues

Impairment of Inventories Impairment of inventories (存货的减值): the cost of inventories may not be recoverable. The value of the inventories drop below their historical cost. Inventory value<cost

Impairment of Inventories How do we know we have an impairment of inventories? 如何判断存货存在减值迹象？ Impairment is incurred: If those inventories are damaged 被损坏 If inventories have become wholly or partially obsolete 部分或全部过时 If their selling prices have declined 市价下跌 If the estimated costs of completion or the estimated costs to be incurred to make the sale have increased. 估计的完工成本或估计的销售费用上涨

Impairment of Inventories When the impairment of inventories has incurred, we use LCM method to measure the inventories. LCM method: lower-of-cost-or-market method (成本与市价孰低法) Compare cost with current market value Market value<Cost Inventory value=MV Impairment is incurred. Cost<Market value Inventory value=cost Impairment is not incurred.

How to use LCM method What is the “cost”? “Cost” refers to the “cost of ending inventory” How to calculate the “cost of ending inv.”? “Cost of ending inventory” is calculated by specific identification, average cost, FIFO, LIFO method which were discussed in Chapter 3

How to use LCM method What is the “market value”? “Market value” refers to the “Net realizable value (NRV)” of inventories. How to calculate the “NRV”? Inventories held for sale 持有以备出售的存货 Such as finished goods (also called merchandising inventory) NRV=estimated selling price – disposal costs 可变现净值=估计售价–处置成本(销售费用及相关税费)

How to use LCM method How to calculate the “NRV”? Inventories held for use in the production 持有用于生产的存货 Usually they are raw materials or work-in-process. Also called manufacturing inventory. NRV=estimated selling price – estimated costs of completion – disposal costs 可变现净值=估计售价–至完工时估计将要发生的成本–处置成本(销售费用及相关税费)

Exercise P167 E4-2 (1) Calculate the NRV for each product. (2) Determine the inventory’s value for each product by applying the LCM method.

Exercise P167 E4-2 Only the Product 2 is impaired. Product NRV Cost LCM 1 34 20 2 80 90 3 60 50

Adjusting Cost to Market When a company uses the LCM method to value inventories (if inventory value<cost), a write-down (减值) of inventory is required. Dr. Loss on write-down of inventory (存货减值损失) Cr. Inventory valuation allowance (存货跌价准备)

Exercise P167 E4-2 Only the Product 2 is impaired. Product NRV Cost LCM 1 34 20 2 80 90 3 60 50

Example Impairment loss of Product 2 =90-80=10 Dr: Loss on write-down of inventory 10 Cr: Inventory valuation allowance 10

Applying LCM method The LCM method can be applied to individual inventory items, logical inventory categories, or the entire inventory. 市价与成本孰低法可以应用于个别存货项目、存货组合或者整体存货。 Usually: use LCM method on individual inventory item 通常对单个存货项目计提减值 Under certain circumstances: use LCM method on logical inventory categories or the entire inventory 在某些特殊情况下，对存货组合或整体存货计提减值

Applying LCM method Suppose we have five inventory items: A, B, C, D, E. Item Cost Market value (NRV) A 50,000 65,000 B 100,000 90,000 C 80,000 D 56,000 E 95,000 86,000

Applying LCM method Items A-B and items C-E are two collections of similar items that can be considered as two logical inventory categories. Inventory category Ⅰ Inventory category Ⅱ Item A Item B Item C Item D Item E

Applying LCM method Use LCM to determine the inventory value. Three applications: Apply LCM method to individual inventory item. Item Cost NRV Inventory value A 50,000 65,000 B 100,000 90,000 C 80,000 D 56,000 E 95,000 86,000 Total 415,000 347,000

Adjusting Cost to Market Write-down of inventory =415,000-347,000=68,000 Dr. Loss on write-down of inventory 68,000 Cr. Inventory valuation allowance 68,000

Applying LCM method Apply LCM method to logical inventory categories. Item Cost NRV Inventory value A 50,000 65,000 B 100,000 90,000 A+B (Ⅰ) 150,000 155,000 C 80,000 D 56,000 E 95,000 86,000 C+D+E (Ⅱ) 265,000 207,000 Total 415,000 357,000

Adjusting Cost to Market Write-down of inventory =415,000-357,000=58,000 Dr. Loss on write-down of inventory 58,000 Cr. Inventory valuation allowance 58,000

Applying LCM method Apply LCM method to the entire inventory. Item Cost NRV Inventory value A 50,000 65,000 B 100,000 90,000 C 80,000 D 56,000 E 95,000 86,000 Total 415,000 362,000

Adjusting Cost to Market Write-down of inventory =415,000-362,000=53,000 Dr. Loss on write-down of inventory 53,000 Cr. Inventory valuation allowance 53,000

Applying LCM method Compare three applications: Apply LCM to individual inventory item, Inventory value=$347,000 Apply LCM to logical inventory categories, Inventory value=$357,000 Apply LCM to the entire inventory, Inventory value=$362,000 Applying LCM to groups of inventory items will usually cause a higher inventory valuation than if applied on an item-by-item basis. 用“市价与成本孰低法”对存货组合(或整体存货)计算出的存货价值会高于对单个存货计算出的存货价值。

Exercise Product Cost NRV L1 $120,000 $100,000 L2 $90,000 $110,000 L3 $60,000 $50,000 L4 $30,000 Determine the amount of the impairment loss from write-down of inventory, applying the LCM method to: Individual items Inventory categories (suppose product L1 and L2 are in category A and product L3 and L4 are in category B) The entire inventory Make journal entries under above three conditions.

Reversal of write-down When the circumstances that previously caused inventories to be written down below cost no longer exist, the amount of the write-down is reversed.当以前减记存货价值的影响因素已经消失时，可以转回计提的存货跌价准备。 when there is an increase in NRV of inventories, the amount of the write-down should be reversed.

Reversal of write-down The reversal should be limited to the amount of the original write-down.转回的金额应以原已计提的存货跌价准备的金额为限。（将存货跌价准备余额冲减至零为止） When there is a reversal, Dr: Inventory valuation allowance Cr: Loss on write-down of inventory

Inventory estimation methods Usually, we use inventory estimation methods to estimate the cost of ending inventory at the end of every month. 通常，我们用存货估计法对月末存货的成本进行估价。 Then, we use inventory valuation methods to adjust the estimated cost of ending inventory at the end of each quarter/half-year/year. 待季末、半年末、年末时，再采用存货的计价方法，对估算的存货成本作出调整。 Inventory estimation methods: Gross profit method 毛利率法 Retail inventory method 零售价法

Gross profit method 毛利率法 How to use the gross profit method? Estimate the “cost of goods sold”. We should know: net sales (销售净额), historical gross profit ratio (历史毛利率) Estimated cost of goods sold=net sales×(1-gross profit ratio) Estimate the “cost of ending inventory”. Estimated cost of ending inventory=beginning inventory + purchases – estimated cost of goods sold

Example Suppose Southern Wholesale Company began 2011 with inventory of $600,000. Company records indicate inventory purchases of $1,500,000 and net sales of $2,000,000. The gross profit ratio in each of the previous three years has been very close to 40%. Estimated cost of goods sold=2,000,000×(1-40%)=1,200,000 Estimated cost of ending inventory =600,000+1,500,000-1,200,000=900,000

Gross profit method 毛利率法 Sometimes we may know the “markup on cost” instead of “gross profit ratio”. Markup on cost (成本加成率)=profit/cost Gross profit ratio=1-1/(1+markup on cost)

Example Suppose Southern Wholesale Company began 2011 with inventory of $600,000. Company records indicate inventory purchases of $1,500,000 and net sales of $2,000,000. Historical markup on cost was 2/3. Gross profit ratio=1-1/(1+2/3)=40% Estimated cost of goods sold=2,000,000×(1-40%)=1,200,000 Estimated cost of ending inventory =600,000+1,500,000-1,200,000=900,000

Exercise P168 E4-11

Retail inventory method 零售价法 This method is commonly used by many retail companies. The retail inventory method uses the cost-to-retail percentage based on a current relationship between cost and selling price. 零售价法采用的是建立在当前成本与销售价格之间关系的“成本占零售价的比例”。

Retail inventory method 零售价法 Cost-to-retail percentage is calculated as follows:

Retail inventory method 零售价法 Ending inv. at retail=beginning inv. at retail + inv. purchase at retail – net sales 期末存货售价=期初存货售价+本期购货售价–销售净额 Ending inv. at cost (cost of ending inv.)=ending inv. at retail × cost-to-retail percentage 期末存货成本=期末存货售价×成本占零售价的比率

Example: Illustration 4-3 Home Improvement Company uses the retail inventory method to estimate ending inventory and cost of goods sold. cost retail Beginning inventory 60,000 100,000 Inventory purchases 287,200 460,000 Net sales=$400,000

Exercise DK Super Stores Inc. uses the average cost retail method to estimate its ending inventory. Information at June 30, 2011, is as follows: Cost Retail Beginning inventory $105,000 Net purchases 375,000 Net sales 380,000 Ending inventory $64,000 Required: Compute the cost-to-retail percentage used by DK.

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