When using the retail inventory method which of the following is deducted from the retail column in the same way as sales?

GAAP requires companies to report inventory at

the lower of cost and net realizable value

• so does IFRS
• GAAP used to call it lower of cost or market. "Market" was defined as replacement cost

The lower of cost and net realizable value approach to valuing inventory avoids

reporting inventory at an amount greater than the benefits it can provide

• causes losses to be recognized in the period the value of inventory declines below its cost rather than in the period in which the goods ultimately are sold

The practice of recognizing decreases but not increases for lower of cost and net realizable value is consistent with

conservatism

• we don't recognize increases in the value of inventory prior to sale because it would, in most cases, result in premature revenue recognition

What is net realizable value (NRV)

the estimated selling price of the product in the ordinary course of the business reduced by reasonably predictable costs of completion, disposal, and transportation ex. sales commissions and shipping costs
the net amount a company expects to realize from the sale of the inventory

Lower of cost and net realizable value can be applied to 

individual inventory items, to logical categories of inventory, or to the entire inventory

• for income tax purposes, the rule has to be applied on an individual item basis
• each approach is acceptable but must be applied consistently each period

Applying the lower of cost and net realizable value rule to groups of inventory times usually will cause

a higher inventory valuation than if applied on an item-by-item basis 

If inventory write-downs are commonplace for a company, losses usually are included in COGS. However,

when a write-down is substantial and unusual, GAAP requires that the loss be expressly disclosed. Can be done either with a disclosure note or by reporting the loss in a separate line in the income statement 

How GAAP and IFRS differ in lower of cost and net realizable value

IFRS permits reversals if circumstances indicate that an inventory write-down is no longer appropriate GAAP doesn't permit reversals
IFRS usually applies lower of cost and net realizable value to individual items. Sometimes logical inventory categories is allowed under certain circumstances GAAP can apply it to individual items, logical inventory categories, or the entire inventory

Inventory write-downs are needed when 

the net realizable values for the individual product, category applications, or total inventory is lower than cost 

When it is either impossible or infeasible to determine the dollar amount of ending inventory by taking a count of the physical quantity of inventory on hand at the end of a period, companies can estimate inventory by either

• the gross profit method

or

• the retail inventory method

The gross profit method (gross margin method) is useful in situations where

estimates of inventory are desirable

• provides only an approximation of inventory
• not acceptable according to GAAP for annual financial statements
  

Situations where the gross profit method is valuable

• in determining the cost of inventory that has been lost, destroyed, or stolen
• in estimating inventory and cogs for interim periods, avoiding the expense of a physical inventory count
• in auditors' testing of the overall reasonableness of inventory amounts reported by clients
• in budgeting and forecasting

Ending inventory and cogs always equal

the cog available for sale 

When using the gross profit method, the ending inventory is

not known

• instead, the amount of sales is known, from which we can estimate the cogs to calculate EI

A first step in estimating inventory using the gross profit method is to

estimate cogs

• this estimate relies on the historical relationship among net sales, cogs, and gross profit
  

Because the gross profit method provides only an estimate, the key to obtaining good estimates is 

the reliability of the gross profit ratio

• the company's cost flow assumption should be implicitly considered when estimating the gross profit ratio

Another difficulty with the gross profit method is that it does not explicitly consider

possible theft or spoilage of inventory

• the method assumes that if the inventory was not sold, then it must be on hand at the end of the period
• suspected theft or spoilage would require an adjustment to estimates obtained using the gross profit method

when the gross profit is stated as a % of cost instead of sales (gross profit ratio)

Similar to the gross profit method, the retail inventory method

• relies on the relationship between cost and selling price to estimate EI and cogs
• its principal benefit is that a physical count of inventory is not required to estimate EI and cogs

The retail inventory method is used by 

many retail companies such as Target, JC Penny, Walmart

• though use of the method is declining with the advent of bar coding on more and more retail merchandise

The retail inventory method uses the 

cost-to-retail percentage based on a current relationship between cost and selling price

• tends to provide a more accurate estimate than the gross profit method which is based on a historical gross profit ratio

The increased reliability in the estimate of the cost percentage is achieved by comparing

cogs available for sale w/ goods available for sale at current selling prices

• to use this technique, a company must maintain records of inventory and purchases not only at cost, but also at current selling price
  

Advantages of the retail inventory method

• is acceptable for external financial reporting if the results of applying the method are sufficiently close to what would have been achieved using a more rigorous determination of the cost of EI
• it's allowed by the IRS as a method that can be used to determine cogs for income tax purposes

Advantages of the retail inventory method (cont.)

• different cost flow methods can be explicitly incorporated into the estimation technique
  

we can modify the application of the method to estimate EI and cogs using FIFO, LIFO, or average cost, though FIFO is used infrequently in practice

Like the gross profit method, the retail inventory method also can be used to estimate

• the cost of inventory lost, stolen, or destroyed
• for testing the overall reasonableness of physical counts
• in budgeting and forecasting
• as well as in generating information for interim financial statements

the retail method provides fairly accurate estimates, but a physical count of inventory usually is performed at least once a year to verify accuracy and detect spoilage, theft, and other irregularities 

Changes in the selling prices must be included in the determination of

ending inventory at retail when applying the retail inventory method

original amount of markup from cost to selling price

increase in selling price subsequent to initial markup

elimination of an additional markup 

reduction in selling price below the original selling price 

elimination of a markdown 

When applying the retail inventory method, net markups and net markdowns must be

included in the determination of EI at retail 

When using the retail method to approximate average cost, the cost-to-retail percentage should be based on 

the weighted averages of the costs and retail amounts for all goods available for sale 

The conventional retail method

when we apply the retail inventory method in such a way that the lower of average cost and net realizable value is approximated

• however costs are determined, inventory should be reported in the balance sheet at the lower of cost and net realizable value

We apply the conventional retail method by excluding

markdowns from the calculation of the cost-to-retail percentage

• markdowns still are subtracted in the retail column but only after the percentage is calculated

By not subtracting net markdowns from the denominator, the cost-to-retail percentage is

lower than it was previously

• this will always be the case when markdowns exist
  
• as a result, the cost approximation of EI always will be less when markdowns exist

The logic for using the approximation of the lower of average cost and net realizable value is that 

a markdown is evidence of a reduction in the utility of inventory

• markdowns usually occur when obsolescence, spoilage, overstocking, price declines, or competition has lessened the utility of the merchandise
• to recognize this decline in utility in the period it occurs, we exclude net markdowns from the calculation of the cost-to-retail percentage

Ending inventory at retail is the same using both approaches 

• the average cost method
  

and

• the conventional retail method
  

this is the case regardless of the cost flow method used bc in all approaches this amount reflected the EI at current retail prices

The conventional retail variation could also be applied to 

the FIFO method

• but it's not generally used in combination w/ LIFO

When there's a net increase in inventory quantity during a period, the use of LIFO results in

ending inventory that includes the beginning inventory as well as one or more additional layers added during the period 

When there's a net decrease in inventory layers, LIFO layers are

In applying LIFO to the retail method in the simplest way, we assume that

the retail prices of goods remained stable during the period

• we also assume that no more than one inventory layer is added per year if inventory increases. Each layer will carry its own cost-to-retail percentage

In the LIFO retail method

beginning inventory is excluded from the calculation of the cost-to-retail percentage

Fundamental elements can complicate the retail method

such as returns and allowances, discounts, freight, spoilage, and shortages 

Net purchases is found by 

adding freight-in to purchases and subtracting both purchase returns and purchase discounts

Freight-in and purchases in the retail method

• purchase returns are deducted from purchases on both the cost and retail side (at different amounts)
• freight-in is added only to the cost side in determining net purchases

If the gross method is used to record purchases, 

purchase discounts taken also are deducted in determining the cost of net purchases

Net sales is determined by

subtracting sales returns from sales

• sales returns are not subtracted bc that would cause the inventory to be overstated
• if sales are recorded net of employee discounts, the discounts are added to net sales before sales are deducted in the retail column

Sales discounts don't represent an adjustment in selling price but

a financial incentive for customers to pay early 

Normal shortages (losses that are expected for most retail ventures, spoilage, breakage, etc.) are deducted in the retail column 

after the calculation of the cost-to-retail percentage

Abnormal shortages are deducted 

in both the cost and retail columns before the calculation of the cost-to-retail percentage 

Before calculating the cost-to-retail percentage

freight-in

• added in the cost column

purchase returns

• deducted in both the cost and retail columns

purchase discounts taken (if gross method used to record purchases)

• deducted in the cost column

abnormal shortages (spoilage, breakage, theft)

• deducted in both the cost and retail columns

After calculating the cost-to-retail percentage

normal shortages (spoilage, breakage, theft)

• deducted in the retail column

employee discounts (if sales recorded net of discounts)

• added to net sales

Using the retail method too approximate LIFO is referred to as

the dollar value LIFO retail method

Each layer year in the dollar value LIFO retail method

carries its unique retail price index and its unique cost-to-retail percentage 

Base year retail amounts in the dollar value LIFO retail method 

are converted to layer year retail and then to cost

Which one of the following is deducted from both the cost and retail columns in computing the cost

What is the retail method of inventory costing?

What is the formula of retail inventory method?

What is the retail inventory method quizlet?