Dollar Value LIFO:
Inventory is measured at current prices with increases added to the historical cost of beginning inventory, using current prices, and decreases measured on the basis of the most recent goods purchased, at their historical cost.
Inventory is measured in terms of $, not units, & is adjusted for changing price levels.
A price level index is used to convert the inventory value from LIFO to Dollar-value LIFO.
LIFO - best matching pricing policy: b/c replacement cost, most recent purchases as cost of sales in GAAP methods.
2 potential difficulties:
Keep track of the different unit costs for items acquired on diff dates- cumulative accurate records
Costs can be enormous - for record-keeping costs over times with diff types of products
Distortion may occur when inventory levels decline temporarily and older costs previously inventoried will become a part of COGS (which is diff than the replacement costs)
Therefore, a useful solution is "Dollar-Value LIFO (DV LIFO)" - so that related inventory items are grouped in pools.
Pools - an overall price index to approximate changes in inventory costs can address some problems:
Keep track of annual layers of inventory cost and price indexes for each inventory pool (vs. retaining detailed records of each unit cost of each item puchased over the life of company) - lower record-keeping cost
Items are grouped together and layers are computed annually - reductions in the level of a certain type of item in inventory can offset the the increase in the level of other items in the pool - won't result in the use of older costs in COGS calculation
To apply the DV LIFO - 2 figures are needed:
1. Total Current Cost of the inventory in the pool @ year end (= replacement costs or End Inv under FIFO)
2. Price Index of overall price level compared to the base date (= date the method was 1st adopted)
Lower of Cost or Market or Lower of Cost or NRV Rule (LCM or LCNRV):
Conservatism & Matching Principle: Cost = Original Cost
Market = Middle of 3 #:
1. Ceiling = Net Realizable Value (NRV)
= Selling Price - Disposal Costs
Disposal Costs = cost to complete, freight out, sale commissions
2. Floor = NRV - Normal Profit Margin
3. Replacement Cost = Purchase or Reproduction
Middle of these # is used as market, then compare market with cost and take the LOWER (LCM).
Apply the LCM only to inventory accounted for under the LIFO or retail inventory methods. For all other inventory, apply the simplified Lower of Cost of NRV (LCNRV).
Inventory valuation is based upon:
1. Individual Items
3. Total Inventory
Losses are recognized immediately on the I/S:
Do NOT recover loss (once inventory is written down), no recovery from the write down until the units are sold
Loss on Inventory due to Market Decline xx
Lower of Cost of NRV (LCNRV):
All inventory (other than LIFO or retail inventory) are to be reported on B/S @ LCNRV.
Conservatism principle: company will normally carry inventories on B/S @ LCM (b/c declines in the market value of unsold inventories).
Problem of 2 diff markets in which the company operates:
1. Market in which the company purchases the inventories
2. Market in which the company sells the inventories
So, one will be @ cost and one will be @ market.
There are 3 diff # that need to be computed b4 market can be determined:
1. Replacement costs
2. NRV or Ceiling Cost
3. NRV - Normal Profit Margin (Floor)
Accounting for Merchandise Inventory:
Cost of Inventory (Intended Use):
Includes all costs of acquisition and preparation for sale
E.g. Warehousing costs, Insurance, Repackaging, Freight-In paid by Buyer, Transportation costs paid by Seller for consignments...
DO NOT include: factory expense, unallocated FOH, excessive spoilage, re-handling costs
Goods in Transit:
FOB Shipping Point: Shipped
Title passes to the buyer when the seller deliver goods to common carrier
Included in Buyer's books @ yr
FOB Destination: Received
Title passes to the buyer when the buyer receives the goods from common carrier
Included in Seller's books until received by Buyer
If goods that have been sold are returned, the seller should reduce net sales and add the cost of items back to inventory (when seller has authorized the goods for return).
All costs associated with inventories will remain on the B/S until sale = Matching Principle
Costs: Purchase + Freight-in (paid by Buyer) + Warehousing Costs (prior to resale)
Financing costs are NOT cost of inventory (but Interest Expense).
Costs incurred @ Sale: Freight-out paid by Seller and Sales Commissions = Selling Expense (Matching Principle)
Consignment Inventory: Consignor to Consignee
Includes inventory in B/S
Has Ownership, NOT possession
Costs incurred by consignor in transferring goods to consignee are considered inventory costs until sold
Costs of goods, Freight paid on shipping, Warehouse costs, Advertising, In-transit Insurance
Items are NOT included in B/S
Has possession, NOT ownership
When sold - sales price is given to consignor (after commissions)
COGS from Operating Income:
COGS = Beg Inv + Net Purchases - End Inv
2 Systems for Measuring Inventory Quantities:
1. Periodic Inventory System (= physical inventory count @ yr-end)
End Inv xx
COGS (plug #) xx
2. Perpetual Inventory System (= ongoing and real time)
Sales Revenue 100
Adv: enable company to see how much inventory on hand in real time
Inventory Costing Methods:
FIFO: First In First Out (LISH)
Results in the highest ending inventory, lowest COGS & highest Net Income
LISH = Last In Still Here (End Inv)
If costs are up, COGS understated and NI overstated.
So B/S is ok but I/S is not.
LIFO: Last In First Out (FISH)
Better represents cash flow.
FISH = First Items Still Here (End Inv)
If costs are up, COGS and Profit is ok, but End Inv is understated.
I/S is ok, but B/S is not.
Average Inventory Methods
1. Perpetual (Moving Avg)
computes the average after each purchase
each transaction is processed as it happens
2. Periodic (Weighted Avg)
Total Costs/ Total #