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6-10 Copyright © 2014 John Wiley & Sons, Inc. Weygandt, Financial Accounting, 9/e, Instructor’s Manual (For Instructor Use Only)
a. LCM is an example of the accounting convention of conservatism,
which means that the approach adopted among accounting
alternatives is the method that is least likely to overstate assets and
net income.
b. Under the LCM basis, market is defined as current replacement cost,
usual quantities.
3. Companies apply LCM to the items in inventory after they have used one
of the cost flow methods to determine cost.
H. Inventory Errors.
1. The effects of inventory errors on net income of the current year are:
income).
b. An error in ending inventory will have a similar effect on net income
income for the two years will be correct.
2. Errors in ending inventory have no effect on liabilities and have the same
I. Statement Presentation and Analysis.
1. Inventory is classified as a current asset immediately below receivables
in a multiple-step income statement.
2. There should be disclosure in the notes to the financial statements of:
a. the major inventory classifications.
b. the basis of accounting (cost, or lower of cost or market).
c. the costing method (FIFO, LIFO, or average cost).
is sold during the period.
4. A variant of the inventory turnover is to compute the number of days
turnover.
*J Inventory Cost Flow Methods in Perpetual Inventory Systems.
1. Under FIFO, companies charge to cost of goods sold the cost of the
earliest goods on hand prior to each sale. The results under FIFO in a
perpetual system are the same as in a periodic system.
2. Under LIFO, companies charge to cost of goods sold the cost of the most
recent purchase prior to sale. In a perpetual LIFO system, the company
allocates the latest units purchased prior to each sale to cost of goods sold.
3. Under the moving-average (average cost) method and a perpetual system,
companies compute a new average cost after each purchase. The aver-
age cost is computed by dividing the cost of goods available for sale by
the units on hand.
*K Estimating Inventories—Gross Profit and Retail Inventory Methods.
1. Two circumstances explain why companies sometimes estimate inventories:
a. A casualty such as a fire, flood, or earthquake may make it impossible
to take a physical inventory.
b. Managers may want monthly or quarterly financial statements, but
a physical inventory is taken only annually.
2. There are two widely used methods of estimating inventories:
a. The gross profit method is used in preparing monthly financial state-
ments under a periodic system.
(1) Step 1: Net sales less estimated gross profit equals estimated
cost of goods sold.
(2) Step 2: Cost of goods available for sale less estimated cost of
goods sold (from Step 1) equals the estimated cost of ending
inventory.
(3) The gross profit method is based on the assumption that the
gross profit rate will remain constant.
(4) Companies should not use the gross profit method to prepare
financial statements at the end of the year.
b. When a store has many different types of merchandise at low unit
costs, the retail inventory method is often used.
(1) Under the retail inventory method, a company’s records must show
both the cost and retail value of the goods available for sale.
(2) Step 1: Goods available for sale at retail less net sales equals
ending inventory at retail.
(4) Step 3: Ending inventory at retail multiplied by the cost-to-retail
ratio equals the estimated cost of ending inventory.
A Look at IFRS
market inventory valuation differently.
KEY POINTS
The requirements for accounting for and reporting inventories are more
lines in inventory accounting.
The definitions for inventory are essentially similar under IFRS and GAAP.
Both define inventory as assets held-for-sale in the ordinary course of
business, in the process of production for sale (work in process), or to be
consumed in the production of goods or services (e.g., raw materials).
GAAP.
Both GAAP and IFRS permit specific identification where appropriate. IFRS
actually requires that the specific identification method be used where the
inventory items are not interchangeable (i.e., can be specifically identified).
If the inventory items are not specifically identifiable, a cost flow
identification must be used.
A major difference between IFRS and GAAP relates to the LIFO cost flow
assumption. GAAP permits the use of LIFO for inventory valuation. IFRS
prohibits its use. FIFO and average-cost are the only two acceptable cost
flow assumptions permitted under IFRS.
value is the best estimate of the net amounts that inventories are expected
to realize. GAAP, on the other hand, defines market as essentially
replacement cost.
Copyright © 2014 John Wiley & Sons, Inc. Weygandt, Financial Accounting, 9/e, Instructor’s Manual (For Instructor Use Only) 6-15
Under GAAP, if inventory is written down under the lower-of-cost-or-market
valuation, the new basis is now considered its cost. As a result, the
inventory may not be written back up to its original cost in a subsequent
period. Under IFRS, the write-down may be reversed in a subsequent
period up to the amount of the previous write-down. Both the write-down
and any subsequent reversal should be reported on the income statement
as an expense. An item-by-item approach is generally followed under
IFRS.
Unlike property, plant, and equipment, IFRS does not permit the option of
original cost.
Similar to GAAP, certain agricultural products and mineral products can be
reported at net realizable value using IFRS.
IFRS allows companies to report inventory at standard cost if it does not
differ significantly from actual cost.
LOOKING TO THE FUTURE
income.
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. When prices are rising, FIFO results in a higher ending inventory than LIFO.
True False
sold first.
True False
3. Goods in transit would be included in the ending inventory of the buyer and the seller.
True False
True False
True False
True False
True False
8. Inventory turnover is computed by dividing the cost of goods sold by the ending
inventory.
True False
*9. The gross profit method estimates the cost of ending inventory by applying a gross profit
rate to net sales.
True False
*10. The retail inventory method and the gross profit method are both methods of inventory
estimation.
True False
Multiple Choice
1. The cost flow method that results in the lowest income taxes when prices are rising is
a. average cost.
b. FIFO.
c. LIFO.
d. specific identification.
2. The data below are for Parrett Enterprises:
Beginning inventory 150 units at $2.00
Purchase—August 375 units at $1.50
Purchase—October 150 units at $3.00
inventory under FIFO?
a. $570
b. $743
c. $593
d. $720
a. understated tax liability.
b. overstated cost of goods sold.
c. overstated net income.
d. understated beginning inventory for the next period.
*4. A retail company has goods available for sale of $300,000 at retail and $210,000 at cost,
a. $220,000
b. $154,000
c. $210,000
d. $56,000
*5. Which method might be used to estimate inventory costs when physical inventories are
not taken?
a. First-in, first-out
b. Last-in, first-out
c. Average cost method
d. Gross profit method
ANSWERS TO QUIZ
True/False
Multiple Choice
