Mastering Accounting For Inventory Part IX

It is important to discuss subsequent measurements of inventory, where if you were to purchase inventory, what will the actualized measure be for damage, deterioration, obsolescence, and changes in price levels. And remember, GAAP requires companies to evaluate unsold inventory after every reporting period.

So, we have the Lower of Cost or Net Realizable Value (LCNRV) used for FIFO and Average Cost (essentially non- LIFO or Retail Inventory Method), and Lower of Cost or Market (used for LIFO or Retail Inventory Method). This is used to evaluate inventory write downs, that implicate inventory and net income downward. With LCNRV, NRV = Estimated Selling Price and Cost of Completion, Disposal, or Transportation.

Essentially, the amount that will be realized. So, if NRV is lower than cost, it will require an adjusting write-down entry. If NRV is greater than cost, no adjusting entry is required. And this can be done by Individual Items, which calculates item by item, the NRV or Cost, and then sums the individual components.

You can do it by Category, and then sum the components. Or it can be done by total inventory. So, you potentially can have an adjusting entry if you were to do it by item, but not necessarily, if you were to do it by the total. If it is usual, you will debit COGS and credit Inventory.

If it is unusual and substantial, you will Dr. Loss on Write Down Inventory Expense, and Cr. Inventory. In terms of Lower of Cost or Market (LCM), cost vs. market will always be below the ceiling (Market should not exceed NRV) or above the floor (Market should not be less than NRV by profit margin allowance).

Therefore, the first step is calculating individual item ceilings being (Selling Price – Estimated Selling Costs) and items floors being (Ceiling – (Selling Price * Profit Margin). Then step two is comparing “Cost” to the middle of a Replacement Cost, Ceiling, or Floor.

​Then you will sum the lowest of Cost to the middle, by summing down individual items. There, you can determine if an adjusting entry is required. Gross Profit Method, can help ensure DEAB, which is DETERMINE cost of inventory for subsequent measures (i.e. lost or destroyed), ESTIMATE inventory and COGS for interim reporting (helping avoid expense for inventory counts), AUDITORS testing for reasonableness of inventory amounts, and for BUDGETING/forecasting.

1. Usual methods for calculations are Beginning Inventory + Purchases = Goods Available for Sale – Ending Inventory (via a Physical Count) = COGS;
2. Gross Profit Method = Beginning Inventory + Purchases = Goods Available – ESTIMATED COGS = ESTIMATED Ending Inventory.

Estimated COGS will typically be Gross Profit Percentage of Net Sales. So, the reliability of this method is as good as the estimate of the gross profit ratio, and the accuracy of the estimate can be improved by pooling products. Also note, cost flows should be implicated and adjusting entries are required for lost, theft, or spoilage. Lastly, the Retail Method is helpful, specifically for high volume relaters selling many items at low unit prices (think of Walmart).

1. Therefore, Ending Inventory = Goods available for sale at Retail – Sales. Then Ending Inventory is multiplied by a Cost-to-Retail Percentage, where Cost-to-Retail Percentage = Goods available at Cost / Goods available at Retail.
2. So, Inventory is then Ending * Cost-to-Retail Percentage. And for Retail Inventory Method, it is important to entry net markups and markdown, from potential initial, additional, cancellation markups and/or markdowns.
3. BEFORE COST TO RETAIL PERCENTAGE CALCULATION, you will need to add Freight in the cost column, subtract returns in both columns, subtract purchase discounts in the cost column, and shortages (i.e. theft or spoilage) in both columns.
4. After calculating cost-to-retail percentage, you will deduct any normal shortages (different from the abnormal shortages in the before calculation) and you will add employee discounts to NET Sales.
5. AT AVERAGE COSTS, this means, when calculating Cost to Retail Percentage, you will have Goods Available at Cost/ (Goods Available at retail after + Net Markups and - Net Markdowns). Then subtract sales by goods available at retail.
6. You will then multiply the cost to retail percentage, and then you will have an estimated ending inventory at retail. You multiply the cost-to-retail percentage to estimated inventory at retail, and then you will have estimated COGS.

 
So, if goods available at cost is 500 and at retail is 1000, cost to retail percentage is 50%, and net sales of 600, you will: 1000 – 600 = 400 * .5 = 200 - 50% from the 200, which leaves you an estimated COGS of 100. This was AGAIN AT AVERAGE COST. When you are doing it CONVENTIONALLY, markups are included in the cost-to-retail percentage, but MARKDOWNS ARE NOT (they go after percentage calculation, but before net sales).