Chapter 8
Inventory Valuation
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Apply the lower of cost and net realizable value (LCNRV) rule to value inventory
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Inventory must be recorded at the lower of its cost and its net realizable value.That is, if the
value of inventory is calculated to be higher than the amount that could be recovered by
selling it, then it must be written down.
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LCNRV may be applied to either individual inventory items or categories of inventory.
Estimate the value of inventory using the gross profit method under the periodic inventory
system
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The gross profit method is applied by using the estimated gross profit margin for the period
to calculate the value of ending inventory.
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First, multiply the gross profit margin by sales revenue to estimate gross profit. Second,
subtract gross profit from sales revenue to estimate COGS.Third, subtract the cost of goods
available for sale from COGS to estimate ending inventory.
Estimate the value of inventory using the retail method under the periodic inventory system
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The retail method is applied by first calculating the ratio of cost to retail for the cost of goods
available for sale. Next, this ratio is multiplied by the retail price of ending inventory to
estimate the cost of ending inventory.
Measure a company's management of inventory using inventory ratios
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The inventory turnover ratio is calculated by dividing COGS by the average value of inventory
over the period.This ratio is equal to the number of times inventory was completely purchased
and sold (turned over) during the period.
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A higher inventory turnover ratio means that inventory is less likely to become obsolete
because it is sold more quickly.
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The inventory days on hand is calculated by dividing 365 by the inventory turnover ratio.This
figure is equal to the number of days on average it takes to sell inventory.
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A lower inventory days on hand means that inventory is less likely to become obsolete because
it is sold in fewer days.
Describe ethics relating to inventory
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Management has the ability to manipulate inventory values reported on financial statements.
Inventory values that deliberately manipulated to deceive readers of the financial statements
is unethical and could be considered fraud.
