Good sold to customers in the ordinary course of a trade or business, or materials and other costs that become a part of such goods.
In service businesses, all direct project costss and allocated overhead can be viewed as inventory.
Valuations of Invetories: In the US, why are inventories valued at the lower of cost or market valuation?
2. Tends to lower reported net income at the earliest possible point in time
3. Lowers the book value of inventory for a more realistic comparison with current liability totals.
What is the Lower of Cost or Market valuation method?
LCM is a method that requires a comparison of cost and market value to determine lowest value.
This method may be applied three ways:
- 1. Item-by-item comparison
- 2. Total of similar items comparison
- 3. Total cost v. total market value
General LCM Methodology
1. Determin quantities in inventory
2. Measure the cost of hte quantities in inventory
3. Measures the market value of the intems in inventory
4. Compare cost and market values
5. If market value is lower, write the inventory valuation down.
How do you determin the Physical Quantity in Inventory?
1. GAAS requires that the auditor observe the taking of a physical inventory.
2. Supplemental procedures can be used, but only if the auditor is willing to assume responsiblity for their relative accuracy.
How do you Determin Inventory Cost?
1. Cost is full historical Cost
- Below are four cost flow methods which can be used:
- 1. Specific Identification
- 2. Fist in, first out (FIFO)
- 3. Last in, first out (LIFO)
- 4. Weighted Average
Cost Flow Assumption Notes
- Specific Identification: reality, but easily minipulated.
- FIFO: Good balance sheet, but lag in costs on income statement
- LIFO: Good income statement and taxes, but terrible balance sheet, NOTE LIFO RESERVE
- Average: Note smoothing effect
What are the reasons Inventory Market Value is difficult to calculate?
- - Multiple prices in same market
- - Multiple prices in different markets
- - Effect of quantity discounts
- - Lack of verifiability in audit process
Use replacement csot as surrogate for market value
How do you measure LCM Valuation?
1. Compare invetory cost to inventory market value, selecting the lower value as appropriate.
- 2. If market is lower, reduce inventory book value to the market value:
- DEBIT: Cost of Goods Sold
- CREDIT: Inventory
1. General valuation is lower of cost or net realizable value--real market value, not replacement cost!
2. Cost is meausred useing only FIFO and avera cost methods --- NO LIFO!
3. Writedowns can be reversed if shown to have recovered---NOT UNDER GAAP