ACCT 3723 1st Edition Final Exam Study Guide Chapters 9 and 11 Chapter 9 Inventories Additional Valuation Issues 1 Describe and Apply the Lower Of Cost Or Market Rule a Lower Of Cost Or Market LCM a company abandons the historical cost principle when the future utility revenue producing ability of the asset drops below its original cost i When doubt exists about a particular value of an asset a company should use the lower value for the asset which also reduces net income ii Loss should be recorded when loss occurs not in the period of sale b Why use replacement cost for the market i Decline in the RC usually means a decline in selling price 1 RC allows a consistent rate of gross price ii If reduction in RC fails to indicate reduction in utility then two additional valuation limitations are used 1 Ceiling Net Realizable Value 2 Floor Net realizable value minus the normal profit margin c Net Realizable Value NRV the estimated selling price in the ordinary course of business less reasonable predictable costs of completion and disposal or net selling price d General LCM Rule a company values inventory at LCM with market limited to an amount that is not more than net realizable value ceiling or less than net realizable value less a normal profit margin floor i Establishing a ceiling and a floor prevents companies from over or understating inventory e Designated Market Value the amount that a company compares cost i Always the middle value of replacement cost net realizable value and net realizable value less a normal profit margin 2 Explain When Companies Value Inventories at Net Realizable Value a Net Realizable Value i Permitted by GAAP under the following conditions 1 A controlled market with a quoted price applicable to all quantities 2 No significant costs of disposal rare metals and agricultural products 3 Too difficult to obtain cost figures 3 Explain When Companies Use the Relative Sales Value Method To Value Inventories a Lump Sum Purchase Basket Purchase when a company buys a group of varying units in one purchase i To accurately value each unit the common and most logical practice is to allocate the total among the various units on the basis of their relative sales value 4 Discuss Accounting Issues Related To Purchase Commitments a Purchase commitments i Generally seller retains title to the merchandise ii Buyer recognizes no asset or liability iii If material the buyer should disclose contract details in footnote iv If the contract price is greater than the market price and the buyer expects that losses will occur when the purchase is effected the buyer should recognize losses in the period during which such declines in market prices take place 5 Determine Ending Inventory By Applying The Gross Profit Method a Gross Profit Method Gross Margin Method substitute measure to approximate inventory i Relies on three assumptions 1 Total Goods Beginning Inventory Purchase 2 Goods not sold must be on hand 3 Ending Inventory Sum of Opening Inventory Purchases Sales ii Disadvantages 1 Provides an estimate of ending inventory 2 Uses past percentages in calculation 3 A blanket gross profit rate may not be representative 4 Only acceptable for interim generally quarterly reporting purposes 6 Determine Ending Inventory By Applying The Retail Inventory Method a Retail Inventory Method a method used by retailers to value inventory without a physical count by converting retail prices to cost i Requires retailers to keep 1 The total cost and retail value of goods purchased 2 The total cost and retail value of the goods available for sale 3 The sales for the period ii Widely used for the following reasons 1 To permit the computation of net income without a physical count of inventory 2 As a control measure in determining inventory shortages 3 In regulating quantities of merchandise on hand 4 For insurance information iii Accounting standards require the disclosure of 1 Composition of the inventory inventory financing arrangements and the inventory costing methods employed 2 Consistent application of costing methods from one period to another 3 Inventory composition either in the balance sheet or in a separate schedule in the notes 7 Explain How To Report And Analyze Inventory a Common ratios used in the management and evaluation of inventory levels are i Inventory turnover 1 Inventory Turnover COGS Average Inventory ii Average days to sell the inventory 1 Average Days to Sell Inventory Inventory Turnover 365 Chapter 11 Depreciation Impairments and Depletion 1 Explain The Concept Of Depreciation a Depreciation the accounting process of allocating the cost of tangible assets to expense to those periods expected to benefit from the use of the asset b Allocating costs of long term assets i Fixed assets Depreciation Expense ii Intangibles Amortization Expense iii Natural Resources Depletion Expense 2 Identify the Factors Involved in the Depreciation Process a Three Basic Questions i What depreciable base is to be used ii What is the assets useful life iii What method of cost apportionment is based b Depreciable Base for the Asset i Function of 2 Factors 1 Original Cost 2 Salvage Disposable Value estimated amount that a company will receive when it sells the asset ii Original Cost Salvage Value Depreciation Base c Estimation of Service Life i Companies retire assets for 2 reasons 1 Physical Factors casualty or expiration of physical life normal wear and tear 2 Economic Factors obsolescence a Inadequacy demands a firm have changed b Supersession replacement c Obsolescence 3 Compare Activity Straight Line and Decreasing Charge Methods a Methods of Depreciation i The process requires the method employed be systematic and rational 1 Examples a Activity Method b Straight Line Method c Decreasing Charge Methods Accelerated i Sum of Year s Digits ii Declining Balance Method d Special Methods i Group and Composite Methods ii Hybrid or Combo Methods b Activity Method Variable Charge or Units of Production assumes that depreciation is a function of use or productivity instead of usage of time i Depreciation Charge Cost Salvage X Hours this Year Total Estimated Hours c Straight Line Method considers depreciation as a function of time rather than a function of usage i Depreciation Charge Cost Salvage Total Estimated Hours 1 NOTE that you do not multiply hours this year d Decreasing Charge Methods produce higher depreciation cost in the earlier years and lower charges in later periods i Two Methods 1 Sum of