Dollar-value LIFO Who uses? The companies that maintain a large number of products and expect significant changes in their product mix in future, frequently use dollarvalue LIFO technique. The use of traditional LIFO approaches is common among companies that have a few items and expect very little change in their product mix. Lose verifiability BUT Reduce cost of measurement. Under this method, it is possible to use a single pool. However, companies can use any number of pools according to their requirement. The unnecessary employment of a large number of dollar-value LIFO pools may increase the cost and also reduce the effectiveness of dollar-value LIFO approach. Dollar-value LIFO method is used to alleviate LIFO liquidation problems. Under this method, goods are combined into pools and all increases and decreases in a pool are measured in terms of total dollar value. The pools created under this method are, therefore, known as dollar-value LIFO pools.
The Example Company adopted dollar-value LIFO method on December 31, 2011. The inventory on current prices at the end of 2011 and 2012 was as follows: The inventory prices were increased by 25% during the year 2012. December 31, 2011 (End of year prices) December 31, 2012 (End of year prices) $40,000 $52,800 Required: Compute the amount of inventory at the end of 2012 using dollar-value LIFO method. 1. Compute the value of ending inventory at base-year-prices. It is computed using the following formula: Ending inventory at base-year-prices = $52,800/1.25 = $42,240 2. Compute the real-dollar quantity increase in inventory: = ($42,240 $40,000) = $2,240 3. Value this real dollar quantity increase in inventory at year-end-prices: = $2,240 1.25 = $2,800 The real dollar quantity increase in inventory valued at year-end-prices is usually known as dollar-value LIFO layer (or layer). If this layer is added to the beginning inventory of the year 2012, we would get the total inventory at the end of the year 2012. Beginning inventory (first layer) in terms of 100 Increase during 2012 (second layer) in terms of 125 Dollar value LIFO inventory on December 31, 2012 $40,000 $2,800 42,800
P1.4. Adopted dollar-value LIFO 1.1.2014 (using internal price indexes and multiple pools). The following data available for inventory pool A for the two years following the adoption of LIFO. Compute the internal price index and using dollar-value LIFO method, at what amount should the inventory be reported at 12.31.2015? Inventory At Base-Year Cost At Current Year Cost 1.1.14 $200,000 $200,000 12.31.14 $240,000 $264,000 12.31.15 $256,000 $286,720 Price Index % Beginning inventory (first layer) in terms of 100 Increase during 2014 in terms of 12.31.14 Index Dollar value LIFO inventory on December 31, 2014 Beginning inventory (first layer) in terms of 100 2014 layer Increase during 2015 in terms of 12.31.15 Index Dollar value LIFO inventory on December 31, 2015
The following information belongs to Example 2 Company: Required: Compute the inventory at the end of each year using dollar-value LIFO method. 1. Add two new columns to the original information given; one to show the inventory at base-year-prices and one to show the changes in inventory from prior year. 2.Compute the dollar value inventory: Date Inventory at end-of-year prices Price index (%) Change from prior year December 31, 2009 $400,000 100 $400,000 0 December 31, 2010 $598,000 115 $520,000 120,000 December 31, 2011 $600,000 120 $500,000 (20,000) December 31, 2012 $702,000 130 $540,000 40,000 * The price index of 2010 has been used because no layer has been formed during the year 2011. The ending inventory at base-yearprices ($500,000) is less than the beginning inventory at base-yearprices ($520,000). Hint! A layer is formed only when ending inventory at base-yearprices exceeds the beginning inventory at base-year-prices. Date Inventory at end-of-year prices Price index (percentage) December 31, 2009 $400,000 100 December 31, 2010 $598,000 115 December 31, 2011 $600,000 120 December 31, 2012 $702,000 130 December 31, 2009: $400,000 @ 1.00 = $400,000 December 31, 2010: $400,000 @ 1.00 = $400,000 $120,000 @ 1.15 = $138,000 December 31, 2011: $538,000 $400,000 @ 1.00 = $400,000 $100,000 @ 1.15* = $115,000 December 31, 2012: $515,000 $400,000 @ 1.00 = $400,000 $100,000 @ 1.15 = $115,000 $40,000 @ 1.30 = $52,000 $567,000 Inventory at base-yearprices - - - - - - -
Dollar-value LIFO Periodic Determine ending inventory (EI) Use EI to determine COGS Ending Inventory Need units Inventory in base-year dollars Need cost per unit Price index
P8-8 (Dollar-Value LIFO) Norman s Televisions produces television sets in three categories: portable, midsize, and flat screen. On January 1, 2014, Norman adopted dollar-value LIFO and decided to use a single inventory pool. The company s January 1 inventory consists of: Category Quantity Cost per Unit Total Cost Portable 6,000 $100 $ 600,000 Midsize 8,000 250 2,000,000 Flat screen 3,000 400 1,200,000 17,000 $3,800,000 During 2014, the company had the following purchases and sales: Category No. Purchased Cost per Unit No. Sold Sales Price/Unit Portable 15,000 $110 14,000 $150 Midsized 20,000 300 24,000 405 Flat screen 10,000 500 6,000 600 45,000 44,000 (b) Assume the company uses three inventory pools instead of one. Compute ending inventory, cost of goods sold, and gross profit.
P8-8 (Dollar-Value LIFO) Norman s Televisions produces television sets in three categories: portable, midsize, and flat screen. On January 1, 2014, Norman adopted dollar-value LIFO and decided to use a single inventory pool. The company s January 1 inventory consists of: Category Quantity Cost per Unit Total Cost Portable 6,000 $100 $ 600,000 Midsize 8,000 250 2,000,000 Flat screen 3,000 400 1,200,000 17,000 $3,800,000 During 2014, the company had the following purchases and sales: Category No. Purchased Cost per Unit No. Sold Sales Price/Unit Portable 15,000 $110 14,000 $150 Midsized 20,000 300 24,000 405 Flat screen 10,000 500 6,000 600 45,000 44,000 (a) Compute ending inventory, cost of goods sold, and gross profit.
P8-8 (Dollar-Value LIFO) Norman s Televisions produces television sets in three categories: portable, midsize, and flat screen. On January 1, 2014, Norman adopted dollar-value LIFO and decided to use a single inventory pool. The company s January 1 inventory consists of: Category Quantity Cost per Unit Total Cost Portable 6,000 $100 $ 600,000 Midsize 8,000 250 2,000,000 Flat screen 3,000 400 1,200,000 17,000 $3,800,000 During 2014, the company had the following purchases and sales: Category No. Purchased Cost per Unit No. Sold Sales Price/Unit Portable 15,000 $110 14,000 $150 Midsized 20,000 300 24,000 405 Flat screen 10,000 500 6,000 600 45,000 44,000 (a) Compute ending inventory, cost of goods sold, and gross profit.
Objectives Chapter 9 You should be able to Explain and apply the lower of cost or market rule to inventories under both US GAAP and IFRS (choosing the designated market value) Explain when and how to use an inventory valuation account Explain when and how to account for purchase commitments
Lower of Cost or Market Matching Conservatism
Lower of Cost or Market US GAAP vs. IFRS Ceiling NRV Cost Market Not More Than Replacement Cost Not Less Than GAAP Lower of Cost or Market NRV less Normal Profit Margin Floor
Ending Inventory: Applying the Lower-of-Cost-or-Market Rule U.S. GAAP says that inventory, like most assets, should be carried at original cost (aka historical cost). For inventory, under the conservatism principle, a departure is appropriate if the replacement cost is less than the historical cost. So if inventory can be replaced for less than its original cost, then the difference between the original and replacement cost should be recognized as a loss. Applying the lower-of-cost-or-market rule to ending inventory is accomplished by comparing the cost allocated to ending inventory with the market (replacement) value of the inventory. If the market value exceeds the cost, no adjustment is made and the inventory remains at cost. If the market value is less than the cost, the inventories are written down to market value with an adjusting journal entry. The typical entry is: Dr. Cost of goods sold (or Loss on inventory write down) XX Cr. Inventory XX
E9-1 (Lower of Cost or Market) The inventory of Company on December 31, 2014, consists of the following items. Part No. Quantity Cost per Unit Cost to Replace per Unit 110 600 $90 $100 111 1,000 60 52 112 500 80 76 113 200 170 180 120 400 205 208 121* 1,600 16 14 122 300 240 235 LCOM * Part No. 121 is obsolete and has a NRV of $.20 each as scrap. a) LOCM inventory at 12/31/14, applying LOCM to each item.
Lower of Cost or Market E 9-1b. Part No. Quantity Cost/ Unit Total Cost Cost to Replace per Unit 110 600 $90 $100 111 1,000 60 52 112 500 80 76 113 200 170 180 120 400 205 208 121* 1,600 16 14 122 300 240 235 Total Total Market * Part No. 121 is obsolete and has a NRV of $.20 each as scrap. b) LOCM inventory at 12/31/14, applying LOCM to the total of the inventory.
E9-6: Company uses LOCM for its inventory on an individual-item basis. Inventory at 12/31/13 includes product X, for which per-unit data is: Estimated selling price $45 Cost 40 Replacement Cost 35 Estimated selling expense 14 Normal profit 9 There are 1000 units of product X, and it was incorrectly valued at $35 per unit. All 1000 units were sold in 2014. What was the effect of this error on 2013 and 2014 net income?
P9-10 Lower of Cost or Market a) Calculate the LCOM using the individual item approach. Item Quantity Unit Cost Replacement cost/unit Est. Selling Price/unit Completion & Disposal cost/unit Normal Profit Margin/unit A 1,100 $7.50 $8.40 $10.50 $1.50 $1.80 B 800 8.20 7.90 9.40.90 1.20 C 1,000 5.60 5.40 7.20 1.15.60 D 1,000 3.80 4.20 6.30.80 1.50 E 1,400 6.40 6.30 6.70.70 1.00 Item Quantity Replace ment cost/uni t NRV (Ceiling) NRV- Normal Profit (Floor) Designated Market A 1,100 $8.40 $7.50 B 800 7.90 8.20 C 1,000 5.40 5.60 D 1,000 4.20 3.80 E 1,400 6.30 6.40 Cost LCOM
Item Quantity Cost Total Cost Total LOCM Difference A 1,100 $7.50 B 800 8.20 C 1,000 5.60 D 1,000 3.80 E 1,400 6.40 b) JE to write down ending inventory from cost to market.
The Lower-of-Cost-or-Market Rule and Hidden Reserves Based on conservatism, ending inventory is valued at cost or market value, whichever is lower. Problem: can create hidden reserves Recognizes price decreases immediately Defers price increase recognition until sold US GAAP and IFRS use different market values when applying the lower-of-cost-or-market rule. Under US GAAP the market value is usually the replacement cost. Under IFRS it is normally the realizable value.
E9-9 (Purchase Commitments) Co. has been having difficulty obtaining key raw materials for its manufacturing process. The company therefore signed a long-term noncancelable purchase commitment with its largest supplier of this raw material on 11/30/2014, at an agreed price of $400,000. At 12/31/2014, the raw material had declined in price to $365,000. JE at 12/31/2014: