Intermediate Accounting IFRS Chapter 9 Quiz

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Questions and Answers

What principle does a company abandon when the future utility of an asset drops below its original cost?

  • Realized gain reporting
  • Historical cost principle (correct)
  • Revaluation model
  • Lower-of-cost principle

How is Net Realizable Value (NRV) calculated?

  • Estimated selling price minus historical cost of inventory
  • Historical cost minus estimated completion costs
  • Estimated selling price less estimated costs to complete and selling costs (correct)
  • Estimated selling price plus estimated costs to complete

If Mander AG has inventory costs of €950 and reports a net realizable value of €750, what loss does it report on its income statement?

  • €200 (correct)
  • €150
  • €750
  • €950

In determining the final inventory value under LCNRV, what basis do most companies typically use?

<p>Item-by-item basis (B)</p> Signup and view all the answers

Which of the following costs are factored in when computing Net Realizable Value?

<p>Estimated costs to complete and estimated selling costs (D)</p> Signup and view all the answers

What is the main reason for using an allowance account when recording inventory adjustments to net realizable value?

<p>To avoid directly affecting the Inventory account. (D)</p> Signup and view all the answers

In the event of a recovery of inventory loss, what is the limit for the reversal of the write-down?

<p>The reversal is limited to the original amount of the write-down. (C)</p> Signup and view all the answers

Which of the following statements reflects a deficiency of the LCNRV rule?

<p>Losses are recorded in the period of sale rather than when they occur. (B)</p> Signup and view all the answers

When using the loss method to adjust inventory to NRV, what is reflected on the income statement?

<p>Both the write-down loss and allowance adjustment. (A)</p> Signup and view all the answers

What does the term 'individual-item approach' refer to in inventory valuation?

<p>Assessing each item in the inventory for its individual NRV. (B)</p> Signup and view all the answers

Why is consistency important in applying inventory valuation methods across periods?

<p>To provide comparability in financial results across different time frames. (A)</p> Signup and view all the answers

What is the purpose of the entry for 'Loss Due to Decline of Inventory to NRV'?

<p>To document the decrease in inventory value. (C)</p> Signup and view all the answers

How does the adjustment to net realizable value (NRV) ultimately affect net income?

<p>Inventory write-downs decrease net income. (D)</p> Signup and view all the answers

What is the role of the 'Allowance to Reduce Inventory to NRV' account when reporting inventory?

<p>It represents potential losses from inventory write-downs. (C)</p> Signup and view all the answers

What effect do net realizable value adjustments have on the reporting of inventory in financial statements?

<p>Inventory is reported at lower of cost or net realizable value. (B)</p> Signup and view all the answers

Flashcards

Lower-of-Cost-or-Net Realizable Value (LCNRV)

The accounting principle that requires companies to write down inventory to its net realizable value (NRV) when its future utility falls below its original cost.

Net Realizable Value (NRV)

The estimated selling price of an asset in the ordinary course of business, less estimated costs to complete and make the sale.

Computation of Net Realizable Value (NRV)

The process of calculating the expected proceeds from selling an asset, accounting for any necessary expenses to make the sale.

Determining Final Inventory Value

The process of applying LCNRV to inventory, often done on an item-by-item basis. Companies may adjust individual inventory items to their NRV if their NRV is lower than their cost.

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Methods of Applying LCNRV

The methods for applying LCNRV to inventory, with individual-item valuation being the most common method.

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Individual-Item Approach

A method of valuing inventory where each individual item is assessed for its net realizable value (NRV), resulting in the lowest possible valuation for financial statement purposes.

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Consistent Application of Inventory Valuation Method

Ensuring that the chosen inventory valuation method, such as the individual-item approach or the base-stock method, remains consistent across accounting periods for meaningful financial comparisons.

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Reducing Inventory to NRV

When an item's NRV falls below its cost, the inventory is reduced to NRV for financial reporting purposes, reflecting the potential loss in value.

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Cost-of-Goods-Sold Method

A method to account for NRV adjustments where the cost of goods sold is increased by the difference between the original cost and the NRV.

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Loss Method

A method to account for NRV adjustments where a separate account is created to recognize the loss due to the decrease in NRV.

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Allowance to Reduce Inventory to NRV

An account used to track the difference between the original cost and the adjusted NRV of inventory.

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Recovery of Inventory Loss

When the NRV of inventory increases, the previously recorded NRV write-down is partially or fully reversed, reflecting the recovered value.

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LCNRV Rule

The accounting rule that mandates adjusting inventory to the lower of its cost or net realizable value (LCNRV).

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Conceptual Deficiency of LCNRV Rule: Loss Recognition Timing

The LCNRV rule assumes that a loss in utility occurs in the period the inventory's value declines, not just when it's sold. This can lead to reporting a loss earlier than when the sale actually happens.

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Study Notes

Intermediate Accounting - IFRS Edition, Chapter 9: Inventories

  • Chapter 9 focuses on Additional Valuation Issues regarding inventories
  • This chapter, prepared by Coby Harmon, University of California, Santa Barbara, and Westmont College, is part of the Fourth Edition of Kieso, Weygandt, Warfield's Intermediate Accounting (IFRS Edition)

Lower-of-Cost-or-Net Realizable Value (LCNRV)

  • LCNRV departs from historical cost when an asset's future utility is diminished
  • Net Realizable Value (NRV): Estimated selling price less completion costs and costs to make a sale.
  • Example calculation: Mander AG's unfinished inventory, costing €950, with a sales value of €1,000, completion cost of €50, and selling costs of €200 has an NRV of €750
  • Mander should report inventory on the financial statement at €750 instead of its cost
  • A loss on inventory write-down of €200 (€950 - €750) is reported in the income statement

Valuation Methods

  • Valuation Bases: These include net realizable value, relative standalone sales value, and purchase commitments
  • Gross Profit Method: Businesses often use the gross profit percentage to estimate the value of their inventory
  • Retail Inventory Method: The Retail Inventory Method involves calculating the cost of goods sold based on the relationship between selling prices and cost of merchandise

Other Key Concepts

  • LCNRV disclosures: These disclosures may be based on standard costs, determined using FIFO and reflect net realizable values adjusted for costs of realizing those values.
  • Method of applying LCNRV: usually an item-by-item basis (individual-item), and this approach is typically used to establish the lowest valuation for financial reporting purposes
  • Reporting NRV instead of cost: a company may use an allowance account to reduce inventory to its NRV. A loss due to decline in inventory value is recorded for the difference.
  • Income statement presentation: the presentation of inventory adjustments on the income statement, such as losses due to the decline in inventory, is detailed
  • Use of an allowance: an allowance account, titled Allowance to Reduce Inventory to NRV, is used instead of directly crediting the inventory account for inventory write-downs.
  • Recovery of inventory loss: When the net realizable value (NRV) of inventory increases, the amount of the original write-down is reversed. This reversal is limited to the initial write-down amount
  • Effect on net income: Inventory is adjusted to NRV in subsequent accounting periods.

Presentation and Analysis

  • Reporting Inventories: Financial reporting standards require specific disclosures about accounting policies, carrying amounts by category, fair value less costs to sell, and the amounts expensed during the period
  • Inventory Analysis: Common ratios, such as inventory turnover and average days to sell, are used to assess and strategize about inventory levels
  • Examples of Common Ratios: Illustrative calculations for these ratios are given, using data from companies like Tate & Lyle. Inventory turnover and average days to sell inventory are key indicators in inventory analysis

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Intermediate Accounting - IFRS Edition - Chapter 9 - Inventories PDF

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