Disc Importers

In the case study, Disc Importers, a group of top managers meet in early October 2004 to

decide upon which of the generally accepted methods of inventory valuation should be used in

the preparation of financial statements for the year ended September 30 (Campbell & Mimick,

1984). In order to find the proper method, the controller, McFee, knew the merchandise

inventories should be valued at the lesser of cost or market value (Campbell & Mimick, 1984). In

the meeting, the controller wanted to know which definition of cost would be best as well as if it

would be better to use replacement cost or net realizable value to compute the inventory’s market

value (Campbell & Mimick, 1984). Below are the purchase records for the 2004 fiscal year.

Purchase Record for the 2004 Fiscal Year

             
Lot Date Quantity Received Unit Purchase Amount Average Freigh Remainin
No. Received (Units) Cost Purchased cost/unit t g
$
O/B   10,000 $4.00 $40,000 4.10 $1,000 2,000
$
#1 Nov. 2003 25,000 4.25 106,250 4.30 1,250 5,000
$
#2 Feb. 2004 30,000 4.35 130,500 4.40 1,500 13,000
$
#3 May. 2004 15,000 4.53 67,950 4.60 1,050 8,000
$
#4 Aug. 2004 40,000 4.61 184,400 4.65 1,600 31,000
Total:   120,000   $529,100   $6,400 59,000
        535500      

Based on these records, the cost of goods available for sale is $535,000. The case study

states that 61,230 units were sold with 500 units returned and 250 damaged units returned.

However, the above records show a physical ending inventory of 59,000 units on hand.

(59,020=58,770+500-250). The 58,770=120,000 units received in inventory-61,230 units sold.

There are 20 units for which were not accounted. The following methods are used below to
describe different ways of inventory valuation which include: FIFO, LIFO, Specific

Identification, and Average Cost.

Conrad Harris, the company’s vice president of finance wanted to show the banker a

method showing that their oldest products are being sold first making the most of their value

(Campbell & Mimick, 1984). The method Harris wanted to use would be First-In, First-Out

method which according to Anthony, Hawkins, and Merchant (2007), “assumes oldest goods are

sold first and that the most recently purchased goods are the ending inventory” (161). The chart

below explains First-In, First-Out for the inventory valuation.

Units Average Unit

FIFO Received Price Valuation
O/B 40,000 $4.65 $186,000
#1 15,000 $4.60 $69,000
#2 4,000 $4.40 $17,600
Total 59,000 $272,600

Using this method, Conrad Harris can show the bankers that the oldest products are being

used and so there is limited waste as well as inflation will not be impacting the overall value of

the products that they are making and selling. The valuation also will show greater than other

methods, which is $272,600.

Bud Bryson, the vice president of marketing, wanted a method that resulted in the cost of

goods sold reflecting the current cost of merchandise to the company in order to obtain an

accurate income statement to measure operating results (Campbell & Mimick, 1984). This most

reflects the inventory valuation method of Last-In-First-Out (LIFO), which assumes the last or

newest piece of inventory is the first one sold (Anthony, Hawkins, & Merchant, 2007). In this

concept, the oldest units remain in stock at the end of the period. Because of LIFO, the remaining

inventory of 59,000 would come from the oldest purchases which would be accounted for from
the opening balance, purchase 1, and purchase 2 inventories. The chart below describes the

inventory valuation using the LIFO method.

Units
LIFO Used Average Unit Price Valuation
O/B 10,000 $4.10 $41,000
#1 25,000 $4.30 $107,500
#2 24,000 $4.40 $105,600
Tota
l 59,000   $254,100
Therefore, the ending value of inventory using the LIFO method is $254,100. With this

method, the COGS reflects the most current inventory which would satisfy Bud Bryson’s want

for an income statement reflecting the current cost of merchandise to the company. The

arguments for LIFO are that results in lower income than FIFO, thus lower taxes.

Dick Spender, the shipping and receiving manager, wanted to use the specific

identification method for inventory valuation. With this method, one uses a means such as a code

affixed to an item to keep track of purchase costs of each item (Anthony, Hawkins, & Merchant,

2007). With this information, they can keep an exact record of costs of inventory with the

tracking already done in purchasing and receiving.

 Specific
Identification
      Method      
Remaining
Cost of Goods Sold: Units Unit Cost Freight Total Cost Quantity Cost of ending inventory
$ $ $ $
  10000 4.00 1,000.00 41,000.00 2000 9,000.00
$ $ $ $
Nov-03 25000 4.25 1,250.00 107,500.00 5000 22,500.00
$ $ $ $
Feb-04 30000 4.35 1,500.00 132,000.00 13000 58,050.00
$ $ $ $
May-04 15000 4.53 1,050.00 69,000.00 8000 37,290.00
$ $ $ $
Aug-04 40000 4.61 1,600.00 186,000.00 31000 144,510.00
             
$ $
Total 120000     535,500.00   271,350.00
             
 Units Sold 62005          
Ending Inventory 59000          
Value of mechandise $
sold 264,150.00          

Cynthia Hamilton, the president of the company, wanted an inventory valuation method

that reflected the average value of each disc within the inventory. She argued that the average

cost method would be good to use because the total inventory cost would be lower and the cost

of goods sold would be slightly higher (Anthony, Hawkins, & Merchant, 2007). A higher report

of cost of goods sold with a decreased income will result in lower taxes and higher retained

earnings. The graph below shows the inventory valuation method if average cost was used. The

final inventory valuation would be $263,140 and the COGS would be $272,060

Avg. Cost 535,500 4.4625

120,000
Average Cost
Method
Avg. Cost
COGS x = Total COGS
61,000 4.46 272,060

End Inv. X Avg. Cost = Total End Inv.

59,000 4.46 263,140
Total Avg. Cost Inv. 535,200
Because manufacturer’s prices increased to $4.70 recently, the market valuation can be

determined by using the replacement cost (cost of new inventory units) or net realizable value

(costs consumers would pay for product). The replacement cost for the 59,000 units of inventory

would be $4.70 x 59,000=$277,300. The net realizable value would need to be calculated from

the $5.50 per unit to its retailer customers. However, the 4% sales commission and delivery

expense of $0.06 per unit need to accounted into the price. The adjusted price in order to find the

net realizable value is $5.50-$0.22-$0.06=$5.22. Thus, the net realizable value is $5.22 x 59,000

units=$307,980.
 Because of the conservatism concept, inventory must be reported on the balance sheet at

the lower of its cost or its market value (Anthony, Hawkins, & Merchant, 2007). In most

ordinary situations, the inventory will be accounted for at its costs, however, inventory is stated

at market cost when there is evidence that inventory is reduced below cost. Evidence of this may

include: physical deterioration, obsolescence, or drops in price level (Anthony, Hawkins, &

Merchant, 2007). In turn, the balance sheet should reflect the “historical cost if that cost is

lowest; otherwise, use the next-to-lowest of the other three possibilities” (Anthony, Hawkins, &

Merchant, 2007). Because the cost-based methods costs resulted in a figure less than the market-

based methods, there will be no adjustments to the ending inventory figures. The chart below

summarizes all the different methods.

Inventory
Valuation Method Type Values
 
FIFO Cost $272,600
LIFO Cost $254,100
 
Spec. ID Cost $267,150
  $272,
Average Cost Cost 060
Marke
Replacement Cost t $277,300
Net Realizable Marke
Value t $307,980
All in all, the group decided to use the valuation method of specific identification because

its cost was the second lowest, however, was more realistic than LIFO as the inventory could be

accounted for through the tracking of bar codes on the units. The result in comparison to the

other methods will result in lower taxable income and income tax payments. The only downside

is that the company will have to report a lower income to its shareholders. However, the lower

tax payment will increase cash flows.