Intermediate Accounting

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Thomas H. Beechy

Schulich School of Business, York University

Joan E. D. Conrod Faculty of Management,

Dalhousie University

PowerPoint slides by:

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b a c k n e x t h o m e

9

Copyright  1998 McGraw-Hill Ryerson Limited, Canada

Chapter 9

Inventories

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9 _{Importance Of Inventories}

■ Inventories typically represent the largest current asset

of manufacturing and retail firms. Inventory should be considered a “high-risk” asset.

■ For many companies, inventories are a

significant portion of total assets as well.

■ Inventory accounting methods and management

practices can become profit-enhancing tools.

■ Inventory effects on profits are more noticeable

when business activity fluctuates

■ Topics: Types of inventory, Basic cost flow

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9 Inventory Categories

■ Inventories consist of costs that have been incurred in an

earnings process that are held as an asset until the earnings process is complete.

■ Inventory may include a wider range of costs incurred and

held in an inventory account for matching against revenue that will be recognized later.

■ Items that may be capital assets to one company may be

inventory to another.

■ The major classifications of inventories depend on the

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9 _{Inventory Categories}

■ Merchandise inventory

-– Goods on hand purchased by a retailer or a trading company such as an importer or exporter for resale.

■ Production inventory

– Raw materials inventory - Tangible goods purchased or obtained in other ways (e.g., by mining) and on hand for direct use in the manufacture or further processing of goods for resale. Parts or subassemblies manufactured before use are sometimes classified as component parts inventory.

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9 Inventory Categories

■ Finished goods inventory - Manufactured or fully processed items

completed and held for sale. Finished goods inventory cost includes the cost of direct material, direct labour, and allocated manufacturing overhead related to its manufacture

■ Production supplies inventory - Items on hand, such as lubrication

oils for the machinery, cleaning materials, as well as small items that make up an insignificant part of the finished product, such as bolts or glue.

■ Contracts in progress - The accumulated costs of performing

services required under contract.

■ Miscellaneous inventories - Items such as office, janitorial, and

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9 _{Inventory Policy Issues}

■ Since cost of goods sold is often the largest single

expense category on the income statement, and

inventory is an integral part of current and total assets, it makes sense that accounting policies in this area can cause income and net assets to change materially. In what areas can policies be set? We’ll look at:

– Items and costs to include in inventory – Cost flow assumptions

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9 Items And Costs Included In Inventory

■ All goods legally owned by the company on the inventory

date, regardless of their location

– Goods in transit depending on the FOB terms

– Goods on consignment

– Repurchase agreements to sell and buy back inventory items

– Special sales agreements

■ A strict legal determination is often

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9 _{Elements Of Inventory Cost}

■ Invoice price

– Total cash equivalent outlay made to acquire the goods and to prepare them for sale or, for a service company, to fulfill the requirements of the service contract.

■ Freight charges and other incidental costs

incurred in connection with the purchase of tangible inventory

■ Purchase Discounts

■ Cash discounts on purchases to

encourage timely payment from buyers

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9 Items Not Included In Inventory

■ (On grounds of materiality), examples include:

– insurance costs on goods in transit,

– material handling expenses, and

– import brokerage and excise fees

– These costs may be included in overhead, which may then be allocated to inventory.

■ General and administrative (G&A) expenses are normally

treated as period expenses because they relate more directly to accounting periods than to inventory.

■ Distribution and selling costs are also considered to be

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9 _{Variable Vs. Fixed Overhead}

■ Manufacturing companies and service firms engaged

in long-term contracts often use variable costing

(also called direct costing, although there are subtle differences between the two approaches) for internal management planning and control purposes.

■ The CICA Handbook recommends that

manufacturers’ inventories include an allocation of overhead:

– In the case of inventories of work in process and finished goods, cost should include the laid-down cost of material

plus the cost of direct labour applied to the product and the

applicable share of overhead expense properly chargeable to production. [CICA 3030.06]

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9

PERIODIC METHOD vs.

PERPETUAL METHOD

Cost Flow Assumptions

■ Periodic inventory system

– Inventory value is determined only at particular times, such as end of the accounting period.

■ Perpetual inventory system

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9 _{Periodic Vs. Perpetual – Illustration}

Lea Company

■ Beginning inventory 500 $4.00 $2,000

■ Purchases 1,000 4.00 4,000

■ Goods available for sale 1,500 $6,000

■ Less: Sales 900

■ Ending inventory, as calculated 600 ■ Ending inventory,

based on physical count 580

■ Shrinkage 20

Unit

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9 Calculating Cost Of Goods Sold (COGS) Lea

Company

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9 _{Periodic Recording}

Lea Company

GENERAL JOURNAL Page 7

Date Description

Post.

Ref. Debit Credit

July 31 Purchases

Accounts Payable

$4,000

$4,000 To Record the purchases

Cost of Goods sold

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9 Perpetual Recording

Lea Company

GEN ER AL JOU RNAL Page 7

Date Description

Post.

Ref. Debit Credit

July 31 Inventory [$1,000 x $4] Accounts Payable $4,000 $4,000 Sales Revenue Accounts receivable [900 x $10] Cost of goods sold [900 x $4]

Inventory

$9,000 $3,600

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9 _{Periodic Vs. Perpetual Recording Methods}

■ Choosing a Recording Method

✜ The choice of a periodic or perpetual system is not really an

accounting policy choice, although modest differences in

inventory and cost of goods sold amounts can arise under the average cost assumption and under LIFO, depending on

which recording method is used. Instead, the choice of

recording method is one of practicality – which method gives the best cost-benefit relationship?

■ Common Cost Flow Assumptions

✜ Specific Identification ✜ Average Cost

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9 Choosing A Recording Method

■ A perpetual inventory system is especially useful when

inventory consists of items with high unit values or when it is important to have adequate but not excessive inventory levels.

■ Perpetual inventory systems require detailed accounting

records and therefore tend to be more costly to implement and maintain than periodic systems. Computer technology has

made perpetual inventory systems more popular today than ever before.

■ Theft and pilferage, breakage and other physical damage,

mis-orders and mis-fills, and inadequate inventory supervision

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9 _{Common Cost Flow Assumptions}

■ LIFO is not a popular method in Canada, due largely to the

fact that it is not acceptable for income tax purposes.

Specific identification is used mainly for large, unique items, such as custom-built equipment, or in accounting for service contracts. For other types of business, average cost and

FIFO are the popular methods

■ According to the CICA Handbook, the

method selected for determining cost should be one which results in the

fairest matching of costs against

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9 Specific Identification

■ At the end of the year (periodic method) or on each sale

(perpetual method) the specific units sold, and their

specific cost, is identified to determine inventory and cost of goods sold.

– In the example in Exhibit 9-2, there are 300 units left in closing inventory.

■ May be inconvenient and difficult to establish just which

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9 _{Average Cost}

■ When the average cost method is used in a periodic

system, it is called a weighted average system.

■ Exhibit 9-3 illustrates

beginning inventory cost

+ total current period purchase costs

number of units in the beginning inventory

+ units purchased during the period

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Unit Total Units Price Cost

Goods available:

1 January ₋ Beginning inventory 200 $1.00 $ 200

9 January ₋ Purchase 300 1.10 330

January ₋ Total available 1,000 $1,120

Weighted-average unit cost ($1,120 _÷ 1,000) 1.12 Ending inventory at weighted-average cost:

31 January 300 1.12 336

Cost of goods sold at weighted-average cost:

Sales during January 700* 1.12 784

Total cost allocated $ 1,120

* 400 units on January 10 plus 300 units on January 18.

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Purchases Sales Inventory Balance

Unit Total Unit Total Unit Total

Date Units Cost Cost Units Cost Cost Units Cost Cost

1 January 200 $1.00 $200 9 January 300 $1.10 $330 500 1.06(a) 530 10 January 400 $1.06 $424 100 1.06 106 15 January 400 1.16 464 500 1.14(b) 570 18 January 300 1.14 342 200 1.14 228 24 January 100 1.26 126 300 1.18(c) 354 Ending inventory $354

Cost of goods sold $766 766 Total cost allocated $1,120 (a) $530 ÷ 500 = $1.06.

(b) $570 ÷ 500 = $1.14. (c) $354 ÷ 300 = $1.18.

Exhibit 9-4 Moving-Average Inventory Cost,

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9 First-In, First-Out

■ The first-in, first-out (FIFO) method treats the first goods

purchased or manufactured as the first units costed out on sale or issuance. Goods sold (or issued) are valued at the oldest unit costs, and goods remaining in inventory are valued at the most recent unit cost amounts.

■ Exhibit 9-5 demonstrates FIFO for the periodic system. ■ Exhibit 9-6 demonstrates the perpetual system.

■ Using the perpetual system, a sale is costed out either

currently throughout the period each time there is a

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Beginning inventory (200 units at $1) $ 200 Add purchases during period (computed as in Exhibit 9-2) 920 Cost of goods available for sale 1,120 Deduct ending inventory (300 units per physical inventory count):

100 units at $1.26 (most recent purchase − 24 January) $126 200 units at $1.16 (next most recent purchase ₋ 15 January) 232

Total ending inventory cost 358 Cost of goods sold $ 762* * Can also be calculated as 200 units on hand 1 January at $1 plus 300 units purchased 9 January at $1.10, plus 200 units purchased 15 January at $1.16.

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Page

7 GENERAL JOURNAL Periodic Perpetual Date Description

Post.

Ref. Debit Credit Debit Credit

Jan 9 Purchases 330

Inventory 330

Cash, etc. 330 330

Jan 10 Cost of goods sold 420

Jan 15 Purchases 464

Cash, etc. 464 464

Jan 18 Cost of goods sold 342

Page

7 GENERAL JOURNAL Periodic Perpetual Date Description

Post.

Ref. Debit Credit Debit Credit

Jan 24 Purchases 126

Cash, etc. 126 126

Jan 31 Cost of goods sold 762 Inventory (closing) 358

Inventory (opening) 200

Purchases 920

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Purchases Sales Inventory Balance Unit Total Unit Total Unit Total Date Units Cost Cost Units Cost Cost Units Cost Cost

1 January 200 $1.00 $200 9 January 300 $1.10 $330 200 1.00 200 300 1.10 330 10 January 200 $1.00 $200 200 1.10 220 100 1.10 110 15 January 400 1.16 464 100 1.10 110 400 1.16 464 18 January 100 1.10 110 200 1.16 232 200 1.16 232 24 January 100 1.26 126 200 1.16 232 100 1.26 126 Ending inventory ($232 + $126) $358

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9 Last-In, First-Out

■ The last-in, first-out (LIFO) method of inventory costing

matches inventory valued at the most recent unit acquisition cost with current sales revenue.

■ The units remaining in ending inventory are costed at

the oldest unit costs incurred, and the units included in cost of goods sold are costed at the newest unit costs incurred, the exact opposite of the FIFO cost

assumption.

■ Like FIFO, application of LIFO requires the use of

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Exhibit 9-7

LIFO Inventory Costing Periodic Inventory System:

Cost of goods available (see Exhibit 9-2) $1,120 Deduct ending inventory (300 units per physical inventory count):

200 units at $1 (oldest costs available, from 1 January inventory) $200 100 units at $1.10 (next oldest costs available; from 9 January purchase) 110

Ending inventory 310

Cost of goods sold $ 810*

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Exhibit 9-8 LIFO Inventory Costing Perpetual Inventory System:

Unit Total Unit Total Unit Total Date Units Cost Cost Units Cost Cost Units Cost Cost

1 January* 200 $1.00 $200 9 January 300 $1.10 $330 200 1.00 200 300 1.10 330 10 January 300 $1.10 $330 100 1.00 100 100 1.00 100 15 January 400 1.16 464 100 1.00 100 400 1.16 464 18 January 300 1.16 348 100 1.00 100 100 1.16 116 24 January 100 1.26 126 100 1.00 100 100 1.16 116 100 1.26 126 Ending inventory ($100 + $116 + $126) $342 Cost of goods sold $778 778 Total cost allocated $1,120 * Beginning inventory.

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9 _{Income Tax Factors}

■ Revenue Canada will not accept LIFO for tax purposes.

Companies must use either the FIFO or the average cost method when they compute their taxes payable. If a company uses LIFO for financial reporting, it must maintain two different inventory costing systems − one for financial reporting (LIFO) and another for income tax (FIFO or average). Since there is a substantial

additional work load to maintaining two different systems, Canadian companies rarely use LIFO.

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9 Review

■ When prices are rising, as they often are:

■ FIFO will produce higher inventory, lower cost of goods sold, and

higher income. It’s probably popular with firms that would like to see higher income and net assets in their financial statements.

■ LIFO has the opposite effect: lower inventories, higher cost of

goods sold, and lower incomes.

■ Average cost methods provide inventory and cost of goods sold

amounts between the LIFO and FIFO extremes, and is the next best thing to LIFO for income and tax minimization when inventory costs are rising.

■ Canadian practice is about evenly divided between FIFO and

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9

_{Exhibit 9-9}

Comparison of the Effects of FIFO vs. LIFO

If purchase

prices are:

The impact on

Ending

inventory is:

The impact on

Cost of goods

sold is:

The impact on

Net income and

retained

earnings is:

Rising

FIFO > LIFO FIFO < LIFO FIFO > LIFO

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9

Disadvantages

■ Does not match current cost

of goods sold with current revenues

■ Inventory (or phantom) profits ■ In periods of rising prices, pay

higher income taxes.

Evaluation Of FIFO

■ Advantages ■ Easy to apply

■ Inventory value approximates current

cost

■ Flow of costs tends to be consistent

with usual physical flow of goods

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9 _{Special Aspects}

■ Standard Cost

■ Just-In-Time Inventory Systems

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9 Standard Cost

■ In manufacturing entities using a standard cost system, the inventories

are valued, recorded, and reported for internal purposes on the basis of a standard unit cost which approximates an ideal or expected cost.

■ This prevents the overstatement of inventory values because it excludes

from inventory all losses and expenses that are due to inefficiency, waste, and abnormal conditions.

■ Actual historical cost is used only once, on acquisition which simplifies

record-keeping significantly!

■ Under this method, the differences between actual cost and standard

cost are recorded in separate variance accounts.

■ These accounts are usually written off as a current period loss rather

than capitalized in inventory.

■ Under standard cost procedures there would be no need to consider

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9 _{Just-In-Time Inventory Systems}

■ Just-in-time (JIT) inventory systems are a response to the high

costs associated with stockpiling inventories of raw materials, parts, supplies, and finished goods

■ The ultimate goal is to see goods and materials arrive at the

company's receiving dock just in time to be moved directly to the plant's production floor for immediate use in the manufacturing or assembly process.

■ Finished goods roll off the production floor and move directly to

the shipping dock just in time for shipment to the customers.

■ The ideal result is zero inventory levels and zero inventory costs. ■ Minimum inventories are needed. If a small buffer inventory is

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9 Inventories Carried At Market Value

■ When revenue is recognized at the point of production, inventory is written

up to its net realizable value, prior to sale. This is the increase in net assets that substantiates revenue recognition.

– Gold Mining

– Farm products

■ Special inventory categories often include items for resale that are

damaged, shopworn, obsolete, defective, or are trade-ins or

repossessions. These inventory items are valued at current replacement cost, defined as the price for which the items can be purchased in their present condition.

■ When the replacement cost cannot be determined reliably, such items

should be valued at their estimated net realizable value (NRV), defined as the estimated sale price less all costs expected to be incurred in

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9 _{Losses On Purchase Commitments}

■ Purchase commitments (contracts) To lock in prices

and ensure sufficient quantities, companies often

contract with suppliers to purchase a specified quantity of materials during a future period at an agreed unit

cost.

■ A loss must be accrued on a purchase contract when:

• the purchase contract is not subject to revision or

cancellation, and

• when a loss is likely and material and

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9 Lower Of Cost Or Market Valuation

■ GAAP requires that inventories be valued either at cost

or at current market value, whichever is less.

■ Assets should always be substantiated by some kind of

future economic benefit.

■ For inventory, it’s clear that if you can’t sell the asset,

the inventory can’t really be called an asset.

■ LCM tests are complicated by a couple of policy

choices:

✜ What is the definition of market value?

✜ Should the LCM test be applied to individual inventory

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9 _{Definition of market value}

■ The basic difficulty with determining market value is that

there are two markets − the supplier market

(replacement cost) and the customer market (sales price).

■ Sales price is called net realizable value (NRV) when

costs expected to be incurred in preparing the item for sale are deducted.

■ Net realizable value can be taken further, deducting

expected costs and also a normal gross profit margin; use of net realizable value less a normal profit

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Exhibit 9-10 Net Realizable Value and Net Realizable Value Less a Normal Profit Margin

a. Inventory item A, at original cost $ 70 b. Inventory item A, at estimated current selling price

in completed condition $100

c. Less: Estimated costs to complete and sell* −40

d. Net realizable value $ 60

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Exhibit 9-11 Methods of Market Determination, 1996

Method

Number of companies,

1996

Net realizable value 142

Replacement cost 43

Net realizable value less normal profit margin 3

Estimated net realizable value 4

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9 Extent of grouping

■ Application of LCM can follow one of three approaches:

• Comparison of cost and market separately for each item of inventory. • Comparison of cost and market separately for each classification of

inventory.

• Comparison of total cost with total market for the inventory.

■ Exhibit 9-12 shows the application of each approach. ■ Consistency in application over time is essential.

■ The individual unit basis produces the most conservative

inventory value because units whose market value exceeds cost are not allowed to offset items whose market value is less than cost. This offsetting occurs to some extent in the other

approaches. The more you aggregate, the less you write down.

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Exhibit 9-12 Application of LCM to Inventory Categories

LCM Applied to Individual

Inventory Types Cost Market Items Classifications Total

Classification A: Item 1 $10,000 $ 9,500 $ 9,500 Item 2 8,000 9,000 8,000 18,000 18,500 $18,000 Classification B: Item 3 21,000 22,000 21,000 Item 4 32,000 29,000 29,000 53,000 51,000 51,000 Total $71,000 $69,500 Inventory valuation

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9 LCM Recording and reporting

■ Two methods of recording and reporting the effects of

the application of LCM are used in practice:

✜ Direct inventory reduction method. The LCM amount, if it is

less than the original cost of the inventory, is recorded and reported each period. Thus, the inventory holding loss is automatically included in cost of goods sold, and ending inventory is reported at LCM.

✜ Inventory allowance method. The inventory holding loss is

separately recorded using a contra inventory account, allowance to reduce inventory to LCM.

– Holding loss on inventory 1,000

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9 _{Cash Flow Statement}

■ To determine the amount of cash provided by

operations, net income must be adjusted by the change in inventory during the period:

• an increase in inventory means that the cash flow to

purchase inventory was higher than the amount of expense reported as cost of goods sold − the increase must be

subtracted from net income in order to reflect higher cash outflow.

• a decrease in inventory means that the cash flow to acquire

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9 Disclosure

■ According to the inventory section of the CICA Handbook,

recommended disclosures are as follows:

• the basis for valuation (e.g., historical cost, lower of cost or market,

market value) [CICA 3030.10];

• major categories of inventory (desirable, not required) [CICA

3030.10];

• method of determining cost, if the method used for determining cost

differs from recent cost of the inventory items [CICA 3030.11];

• a definition of market value (desirable, not required), if ‘market’ is

used in some aspect of inventory valuation [CICA 3030.11]; and

• any change in valuation from that used in the prior period, and the

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9 _{Inventory Estimation Methods}

■ Many large companies rely on the periodic inventory

method. Does this mean that they can’t prepare

monthly or quarterly statements without also taking a physical inventory?

■ So what can be done when statements are needed?

The answer is quite simple: inventory can be estimated.

■ In a small business, the owner or inventory manager

might be able to provide an accurate estimate.

■ Alternatively, a more formal calculation can be made,

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9 Gross Margin Method

■ The gross margin method (also known as the gross

profit method) assumes that a constant gross margin

estimated on recent sales can be used to estimate inventory values from current sales.

■ That is, the gross margin rate (gross margin divided by

sales), based on recent past performance, is assumed to be reasonably constant in the short run.

■ The gross margin method has two basic characteristics

– (1) it requires the development of an estimated gross margin rate for different lines or products, and

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9 Gross Margin Method

Steps To Follow

■ Estimate historical gross margin rate.

■ Add beginning inventory and net purchases to get cost

of goods available for sale(COGAS).

■ Multiply sales by the gross margin rate to get estimate

gross margin in dollars.

■ Subtract gross margin in dollars from net sales to get

cost of goods sold(COGS).

■ Subtract COGS from COGAS to get the estimated cost

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9 Gross Margin Method - Example

■ NoteCo, Inc. uses the gross margin method to estimate

end of month inventory value. At the end of May the controller develops the following information: Gross

margin 43% of sales; Inventory at May 1 $237,400; net purchases for May $728,300; net sales for May

$1,213,000.

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9

Sales for May $ 1,213,000

Cost of goods sold:

Beginning inventory $ 237,400

Net purchases 728,300

Cost of goods available for sale 965,700

Estimated ending inventory 274,290

Cost of goods sold 691,410

Gross margin for May $ 521,590

Gross Margin Method

Solution

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9 Retail Inventory Method

■ The retail inventory method is often used by retail

stores, especially department stores that sell a wide variety of items.

■ In such situations, perpetual inventory procedures may

be impractical, and a complete physical inventory count is usually taken only once annually.

■ The retail inventory method is appropriate when items

sold within a department have essentially the same markup rate and articles purchased for resale are

priced immediately. Two major advantages of the retail inventory method are its ease of use and reduced

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9 _{Markups And Markdowns}

■ To apply the retail inventory method, it is important to

distinguish among the following terms: ✜ Original sales price..

✜ Markup.

✜ Additional markup.

✜ Additional markup cancellation. ✜ Markdown..

✜ Markdown cancellation.

■ In the application of the retail method, markups and markup cancellations,

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9 Gross Margin Method

Steps To Follow

■ Estimate historical gross margin rate.

■ Add beginning inventory and net purchases to get cost

of goods available for sale(COGAS).

■ Multiply sales by the gross margin rate to get estimate

gross margin in dollars.

■ Subtract gross margin in dollars from net sales to get

cost of goods sold(COGS).

■ Subtract COGS from COGAS to get the estimated cost

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9 _{Gross Margin Method - Example}

■ NoteCo, Inc. uses the gross margin method to estimate

end of month inventory value. At the end of May the controller develops the following information: Gross

margin 43% of sales; Inventory at May 1 $237,400; net purchases for May $728,300; net sales for May

$1,213,000.

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9

Sales for May $ 1,213,000

Cost of goods sold:

Beginning inventory $ 237,400

Net purchases 728,300

Cost of goods available for sale 965,700

Estimated ending inventory 274,290

Cost of goods sold 691,410

Gross margin for May $ 521,590

Gross Margin Method

Solution

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9 _{Retail Method}

■ To use this method we must know:

– Sales for the period.

– Beginning inventory at retail and cost. – Net purchases at retail and cost.

– Adjustments to the original retail price:

✜ Additional markups and markdowns, markup and markdown

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9 Retail Method

Steps To Follow

■ Determine cost of goods sold and retail value of goods

sold.

■ Calculate the cost to retail percentage.

■ Subtract retail value of goods available for sale from

sales to get ending inventory at retail.

■ Multiply the cost to retail percentage times ending

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9 Retail Method

Example

■ Webb Clothiers, Inc. uses the retail method to estimate

inventory at the end of each month. For the month of May the controller gathers the following information: Beginning inventory at cost $60,000, at retail $92,000, net purchases at cost $200,000, at retail $308,000; net sales for May $300,000.

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9 RETAIL METHOD -

SOLUTION

Cost Retail

Inventory, May 1 $ 60,000 $ 92,000

Net purchases for May 200,000 308,000 Goods available for sale 260,000 400,000 Cost ratio (260,000 ÷ 400,000)

65%

Sales for May 300,000

Ending inve ntory at retail $ 100,000

Cost ratio 65%

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9 Retail Method

Markups And Markdowns

■ Original Sales Price - sale price first marked on the

merchandise.

■ Markup - original amount by which item is marked up

above cost.

■ Additional Markup - Increase in sales price above the

original sales price.

■ Additional Markup Cancellation - cancellation of some

or all of an additional markup.

■ Markdown - reduction in original sales price

■ Markdown Cancellation - increase is sales price after a

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9

Cost of net purchases FIFO cost ratio =

Retail value of (net purchases + net markups - net markdowns)

Retail Method

Markups And Markdowns

■ Estimating Inventory on a FIFO Basis

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9

Cost of (beginning inventory + net purchases) Retail value of (beginning inventory + net

purchases + net markups - net markdowns) Average

cost = ratio

Retail Method

Markups And Markdowns

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9

Cost of (beginning inventory + net purchases) Retail value of (beginning inventory

+ net purchases - net markups) LCM

cost = ratio

Exclude net markdowns from the ratio.

Retail Method

Markups And Markdowns

(67)

9 _{Summary Of Key Points}

■ Inventories are assets consisting of goods owned by

the business and held for future sale or for use in the manufacture of goods for sale.

■ Cost at acquisition, including the costs to obtain the

inventory, such as freight, is used to value inventory.

■ Work in process and finished goods inventories of

manufacturers should include raw materials, direct labour, and at least the variable portion of

(68)

9 Summary Of Key Points

■ All goods owned at the inventory date, including those

on consignment, should be counted and valued.

■ Either a periodic or a perpetual inventory system may

be used for merchandise inventories and for

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9 _{Summary Of Key Points}

■ Several cost flow assumptions are in current use, including

specific identification, average cost, FIFO, and LIFO. LIFO is very rarely used in Canada, except by subsidiaries of U.S. parent companies that also use that method.

■ Special accounting problems are encountered by firms

using standard cost, just-in-time inventory systems, or net realizable value to recognize inventory.

■ Losses on firm purchase commitments, when they can be

reasonably estimated and are material, are recognized in the accounts if the loss is likely and can be estimated.

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9 Summary Of Key Points

■ The lower-of-cost-or-market (LCM) method of estimating

inventory recognizes declines in market value in the period of decline. The lower-of-cost-or-market method values

inventories at market if market is below cost. Market may be interpreted to be net realizable value, net realizable

value less a normal profit margin, or replacement cost. Use of net realizable value is most common.

■ The gross margin method is used to estimate inventory

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9 _{Summary Of Key Points}

■ The retail method of estimating inventory applies the ratio

of actual cost to sales value to the ending inventory at sales value to estimate the inventory value at lower of cost or

market.

■ The cash flow from operations is affected by (1) changes in