Intermediate Accounting - IFRS Edition - Chapter 9 - Inventories PDF

Intermediate Accounting IFRS Edition Kieso, Weygandt, Warfield Fourth Edition Chapter 9 Inventories: Additio...

Intermediate Accounting IFRS Edition Kieso, Weygandt, Warfield Fourth Edition Chapter 9 Inventories: Additional Valuation Issues Prepared by Coby Harmon University of California, Santa Barbara Westmont College This slide deck contains animations. Please disable animations if they cause issues with your device. Copyright © 2020 John Wiley & Sons, Inc. PREVIEW OF CHAPTER 9 Copyright © 2020 John Wiley & Sons, Inc. 2  Learning Objective 1 Describe and apply the lower-of-cost- or-net realizable value rule. LO 1 Copyright © 2020 John Wiley & Sons, Inc. 3 Lower-of-Cost-or-Net Realizable Value (LCNRV) A company abandons the historical cost principle when the future utility (revenue-producing ability) of the asset drops below its original cost. Net Realizable Value Estimated selling price in the normal course of business less estimated costs to complete and estimated costs to make a sale. LO 1 Copyright © 2020 John Wiley & Sons, Inc. 4 Computation of Net Realizable Value Illustration: Assume that Mander AG has unfinished inventory with a cost of €950, a sales value of €1,000, estimated cost of completion of €50, and estimated selling costs of €200. Mander’s net realizable value is computed as follows. ILLUSTRATION 9.1 Mander reports inventory on its statement of financial position at €750. In its income statement, Mander reports a Loss on Inventory Write- Down of €200 (€950 − €750). LO 1 Copyright © 2020 John Wiley & Sons, Inc. 5 LCNRV Disclosures ILLUSTRATION 9.2 LO 1 Copyright © 2020 John Wiley & Sons, Inc. 6 Determining Final Inventory Value Jinn-Feng Foods computes its inventory at LCNRV (amounts in thousands). ILLUSTRATION 9.3 LO 1 Copyright © 2020 John Wiley & Sons, Inc. 7 Methods of Applying LCNRV In most situations, companies price inventory on an item- by-item basis. Tax rules in some countries require that companies use an individual-item basis. Individual-item approach gives the lowest valuation for statement of financial position purposes. Method should be applied consistently from one period to another. LO 1 Copyright © 2020 John Wiley & Sons, Inc. 8 Recording NRV Instead of Cost Illustration: Data for Ricardo SpA ILLUSTRATION 9.5 LO 1 Copyright © 2020 John Wiley & Sons, Inc. 9 Income Statement Presentation Cost-of-Goods-Sold and Loss Methods of Reducing Inventory to Net Realizable Value ILLUSTRATION 9.6 LO 1 Copyright © 2020 John Wiley & Sons, Inc. 10 Use of an Allowance Instead of crediting the Inventory account for NRV adjustments, companies generally use an allowance account, often referred to as Allowance to Reduce Inventory to NRV. Using an allowance account under the loss method, Ricardo SpA makes the following entry to record the inventory write-down to NRV. Loss Due to Decline of Inventory to NRV 12,000 Allowance to Reduce Inventory to NRV 12,000 ILLUSTRATION 9-7 LO 1 Copyright © 2020 John Wiley & Sons, Inc. 11 Recovery of Inventory Loss Recovery of Inventory Loss Amount of write-down is reversed. Reversal limited to amount of original write-down. Continuing the Ricardo example, assume the net realizable value increases to €74,000 (an increase of €4,000). Ricardo makes the following entry, using the loss method. Allowance to Reduce Inventory to NRV 4,000 Recovery of Inventory Loss 4,000 LO 1 Copyright © 2020 John Wiley & Sons, Inc. 12 Effect on Net Income of Adjusting Inventory to Net Realizable Value Allowance account is adjusted in subsequent periods, such that inventory is reported at the LCNRV. Illustration 9.8 shows net realizable value evaluation for Vuko Company and the effect of net realizable value adjustments on income. ILLUSTRATION 9.8 LO 1 Copyright © 2020 John Wiley & Sons, Inc. 13 Evaluation of LCM Rule LCNRV rule suffers some conceptual deficiencies: 1. A company recognizes decreases in the value of the asset and the charge to expense in the period in which the loss in utility occurs— not in the period of sale. 2. Application of the rule results in inconsistency because a company may value the inventory at cost in one year and at net realizable value in the next year. 3. LCNRV values the inventory in the statement of financial position conservatively, but its effect on the income statement may or may not be conservative. Net income for the year in which a company takes the loss is definitely lower. Net income of the subsequent period may be higher than normal if the expected reductions in sales price do not materialize. LO 1 Copyright © 2020 John Wiley & Sons, Inc. 14  Learning Objective 5 Explain how to report and analyze inventory. LO 5 Copyright © 2020 John Wiley & Sons, Inc. 15 Presentation of Inventories (1 of 2) Accounting standards require disclosure of: 1) Accounting policies adopted in measuring inventories, including the cost formula used (weighted-average, FIFO). 2) Total carrying amount of inventories and the carrying amount in classifications (merchandise, production supplies, raw materials, work in progress, and finished goods). 3) Carrying amount of inventories carried at fair value less costs to sell. 4) Amount of inventories recognized as an expense during the period. LO 5 Copyright © 2020 John Wiley & Sons, Inc. 16 Presentation of Inventories (2 of 2) Accounting standards require disclosure of: 5) Amount of any write-down of inventories recognized as an expense in the period and the amount of any reversal of write- downs recognized as a reduction of expense in the period. 6) Circumstances or events that led to the reversal of a write- down of inventories. 7) Carrying amount of inventories pledged as security for liabilities, if any. LO 5 Copyright © 2020 John Wiley & Sons, Inc. 17 Analysis of Inventories Common ratios used in the management and evaluation of inventory levels are inventory turnover and average days to sell the inventory. LO 5 Copyright © 2020 John Wiley & Sons, Inc. 18 Analysis of Inventories Inventory Turnover Measures the number of times on average a company sells the inventory during the period. Illustration: In its 2019 annual report Tate & Lyle plc (GBR) reported a beginning inventory of £419 million, an ending inventory of £434 million, and cost of goods sold of £1,621 million for the year. ILLUSTRATION 9.25 LO 5 Copyright © 2020 John Wiley & Sons, Inc. 19 Analysis of Inventories Average Days to Sell Inventory Measure represents the average number of days’ sales for which a company has inventory on hand. ILLUSTRATION 9.25 LO 5 Copyright © 2020 John Wiley & Sons, Inc. 20 Copyright Copyright © 2020 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Copyright © 2020 John Wiley & Sons, Inc. 21