Ch09 Kieso Ifrs4

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
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Copyright ©2020 John Wiley & Sons, Inc.
Learning Objectives
After studying this chapter, you should be able to:

LO 1 Describe and apply the lower-of-cost-or-net realizable
value rule.
LO 2 Identify other inventory valuation issues.
LO 3 Determine ending inventory by applying the gross profit
method.
LO 4 Determine ending inventory by applying the retail
inventory method.
LO 5 Explain how to report and analyze inventory.
Copyright ©2020 John Wiley & Sons, Inc. 2

PREVIEW OF CHAPTER 9

Learning Objective 1
Describe and apply the lower-of-cost-
or-net realizable value rule.
LO 1 Copyright ©2020 John Wiley & Sons, Inc. 4

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.

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).
LCNRV Disclosures
ILLUSTRATION 9.2

Determining Final Inventory Value
Jinn-Feng Foods computes its inventory at LCNRV (amounts in

thousands).
ILLUSTRATION 9.3

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.

Alternative Applications of LCNRV
Assume that Jinn-Feng Foods separates its food products into two
major groups, frozen and canned.
ILLUSTRATION 9.4

Recording NRV Instead of Cost
Illustration: Data for Ricardo SpA
ILLUSTRATION 9.5

Income Statement Presentation
Cost-of-Goods-Sold and Loss Methods of
Reducing Inventory to Net Realizable Value
ILLUSTRATION 9.6

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 N RV 12,000
Allowance to Reduce Inventory to NRV 12,000
ILLUSTRATION 9-7

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

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

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.

LCNRV Problem
P9.1 Remmers SE manufactures desks. Most of the company’s desks are standard models and are
sold on the basis of catalog prices. At December, 2022, the following finished desks appear in the
company’s inventory. The 2022 catalog was in effect through November 2022, and the 2023 catalog is
effective as of December 1, 2022. All catalog prices are net of the usual discounts. At what amount
should each of the four desks appear in the company’s December 31, 2022, inventory, assuming that
the company has adopted a lower-of-F IFO-cost-or-net realizable value approach for valuation of
inventories on an individual-item basis?
Finished Desks A B C D
2022 catalog selling price €450 €480 €900 €1,050
FIFO cost per inventory list 12/31/22 470 450 830 960
Estimated cost to complete and sell 50 110 260 200
2023 catalog selling price 500 540 900 1,200

LCNRV Problem Solution
Item Cost Net Realizable Value* Lower-of-Cost-or-NRV

A €470 €450 €450
B 450 430 430
C 830 640 640
D 960 1,000 960
*Net Realizable Value = 2023 catalog selling price less estimated costs
to complete and sell. (2023 catalog prices are in effects as of 12/01/22.)

Identify other inventory valuation
issues.

Valuation Bases
Departure from LCNRV rule may be justified in situations

when
• cost is difficult to determine,
• items are readily marketable at quoted market prices, and
• units of product are interchangeable.
Two common situations in which NRV is the general rule:
• Agricultural assets
• Commodities held by broker-traders.

Agricultural Inventory—Biological Asset
Biological asset (classified as a non-current asset) is a living

animal or plant, such as sheep, cows, fruit trees, or cotton
plants.
• Biological assets are measured on initial recognition and at
the end of each reporting period at fair value less costs to
sell (NRV).
• Companies record gain or loss due to changes in N RV of
biological assets in income when it arises.

Agricultural Inventory—Agricultural Produce
Agricultural produce is the harvested product of a biological

asset, such as wool from a sheep, milk from a dairy cow,
picked fruit from a fruit tree, or cotton from a cotton plant.
• Agricultural produce are measured at fair value less costs
to sell (NRV) at the point of harvest.
• Once harvested, the NRV becomes cost.

Agricultural Accounting at NRV
Illustration: Bancroft Dairy produces milk for sale to local cheese

makers. Bancroft began operations on January 1, 2022, by
purchasing 420 milking cows for €460,000. Bancroft provides the
following information related to the milking cows.
ILLUSTRATION 9.9

Journal Entry to Record Change in Carrying Value
As indicated, the carrying value of the milking cows increased during
the month. Part of the change is due to changes in market prices for
milking cows. The change in market price may also be affected by
growth—the increase in value as the cows mature and develop
increased milking capacity. At the same time, as mature cows are
milked, their milking capacity declines (fair value decrease due to
harvest. Bancroft makes the following entry to record the change in
carrying value of the milking cows.
Biological Asset (milking cows) (€493,800 - €460,000) 33,800
Unrealized Holding Gain or Loss—Income 33,800

Financial Statement Presentation

Two More Journal Entries
Illustration: Bancroft makes the following summary entry to record
the milk harvested for the month of January.
Inventory (milk) 36,000
Unrealized Holding Gain or Loss ─ Income 36,000
Assuming the milk harvested in January was sold to a local cheese

maker for €38,500, Bancroft records the sale as follows.
Cash 38,500
Cost of Goods Sold 36,000
Inventory (milk) 36,000
Sales Revenue 38,500

Commodity Broker-Traders
Generally measure their inventories at fair value less costs to

sell (NRV), with changes in NRV recognized in income in the
period of the change.
• Buy or sell commodities (such as harvested corn, wheat,
precious metals, heating oil).
• Primary purpose is to
o sell the commodities in the near term and
o generate a profit from fluctuations in price.

Relative Standalone Sales Value
Used when buying varying units in a single lump-sum

purchase.
Illustration: Woodland Developers purchases land for $1
million that it will subdivide into 400 lots. These lots are of
different sizes and shapes but can be roughly sorted into
three groups graded A, B, and C. As Woodland sells the lots, it
apportions the purchase cost of $1 million among the lots
sold and the lots remaining on hand. Calculate the cost of lots
sold and gross profit.

Allocation of Costs, Using Relative
Standalone Sales Value and Determination
of Gross Profit
ILLUSTRATION 9.10
ILLUSTRATION 9.11

Purchase Commitments—A Special
Problem
• Generally seller retains title to the merchandise.
• Buyer recognizes no asset or liability.
• If material, the buyer should disclose contract details in
note in the financial statements.
• If the contract price is greater than the market price, and
the buyer expects that losses will occur when the
purchase is effected, the buyer should recognize a liability
and corresponding loss in the period during which such
declines in market prices take place.

Purchase Commitments (1 of 2)
Illustration: Apres Paper AG signed timber-cutting contracts with
Galling Land Ltd. to be executed in 2023 at a price of €10,000,000.
Assume further that the market price of the timber cutting rights
on December 31, 2022, dropped to €7,000,000. Apres would make
the following entry on December 31, 2022.

Purchase Commitments (2 of 2)
Illustration: When Apres cuts the timber at a cost of €10

million, it would make the following entry.
Purchases (Inventory) 7,000,000
Purchase Commitment Liability 3,000,000
Cash 10,000,000
Assume that Galling Land Ltd. permits Apres to reduce its

commitment from €10,000,000 to €9,000,000. Apres would
make the following entry.
Purchase Commitment Liability 1,000,000
Unrealized Holding Gain or Loss—Income 1,000,000

Determine ending inventory by
applying the gross profit method.

Gross Profit Method of Estimating
Inventory
Substitute Measure to Approximate Inventory
Relies on three assumptions:
1. Beginning inventory plus purchases equal total goods to
be accounted for.
2. Goods not sold must be on hand.
3. The sales, reduced to cost, deducted from the sum of the
opening inventory plus purchases, equal ending inventory.

Application of Gross Profit Method
Illustration: Cetus SE has a beginning inventory of €60,000 and

purchases of €200,000, both at cost. Sales at selling price amount
to €280,000. The gross profit on selling price is 30 percent. Cetus
applies the gross margin method as follows.
ILLUSTRATION 9.13
Computation of Gross Profit Percentage
Illustration: In Illustration 9.13, the gross profit was a given. But

how did Cetus derive that figure? To see how to compute a gross
profit percentage, assume that an article cost €15 and sells for €20,
a gross profit of €5.
ILLUSTRATION 9.14

Formulas Relating to Gross Profit and
Application of Formulas
ILLUSTRATION 9.15
ILLUSTRATION 9.16

Gross Profit Method Problem
E9.14 Astaire ASA uses the gross profit method to estimate

inventory for monthly reporting purposes. Presented below is
information for the month of May.
Inventory, May 1 € 160,000 Sales € 1,000,000
Purchases (gross) 640,000 Sales returns 70,000
Freight-in 30,000 Purchases discounts 12,000
Instructions:
a. Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of sales.
b. Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of cost.
Solution for a.
a. Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of sales.

Solution for b.
b. Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of cost.

Evaluation of Gross Profit Method
Disadvantages
1) Provides an estimate of ending inventory.
2) Uses past percentages in calculation.
3) A blanket gross profit rate may not be representative.
4) Normally unacceptable for financial reporting purposes
because it provides only an estimate.
IFRS requires a physical inventory as additional verification of the
inventory indicated in the records.
Note that the gross profit method will follow closely the inventory
method used (FIFO or average-cost) because it relies on historical
costs.
Determine ending inventory by applying
the retail inventory method.

Retail Inventory Method
Method used by retailers to compile inventories at retail prices.

Retailer can use a formula to convert retail prices to cost.
Requires retailers to keep a record of:
1) Total cost and retail value of goods purchased.
2) Total cost and retail value of the goods available for sale.
3) Sales for the period.
Methods
• Conventional Method (or LCNRV)
• Cost Method

Retail Inventory Method Concepts
Markup—an additional markup of the original retail price.

Markup cancellations—decreases in prices of merchandise that
the retailer had marked up above the original retail price.
Markdowns—decreases in the original sales prices.
Markdown cancellations—occur when the markdowns are later
offset in increases in the prices of goods that the retailer had
marked down.
Neither a markup cancellation nor a markdown cancellation can
exceed the original markup or markdown.

Retail Inventory Method Concepts
Cost Ratios
Conventional Retail Method—Computes a ratio after net markups

but before net markdowns.
Cost Method—Computes a ratio after both net markups and
markdowns.

Net Markups and Net Markdowns
Designer Clothing Store recently purchased 100 dress shirts from

Marroway Group. The cost for the shirts was €1,500, or €15 per shirt.
Designer Clothing established the selling price on these shirts at €30 a
shirt. The shirts were selling quickly, so the manager added a markup of
€5 per shirt. This markup made the price too high for customers, and
sales slowed. The manager then reduced the price to €32. At this point,
we would say that the shirts at Designer Clothing Company have had a
markup of €5 and a markup cancellation of €3.
A month later, the manager marked down the remaining shirts to a sales
price of €23. At this point, an additional markup cancellation of €2 has
taken place, and a €7 markdown has occurred. If the manager later
increases the price of the shirts to €24, a markdown cancellation of €1
would occur.
Data for Retail Inventory Method
Example
In-Fusion SA can calculate its ending inventory under two assumptions, A and B.
Assumption A: Computes a cost ratio after net markups but before net
markdowns. This assumption is referred to as conventional retail or LCNRV.
Assumption B: Computes a cost ratio after both net markups and net
markdowns. This assumption is referred to as referred to as the cost method.
In-Fusion data for calculating ending inventory at cost under the two
assumptions is as follows.
ILLUSTRATION 9.18

Cost-to-Retail Ratios for Assumptions A
and B
ILLUSTRATION 9.18

Value of Ending Inventory for In-Fusion

Comprehensive Conventional Retail
Inventory Method Format
ILLUSTRATION 9.21

Special Items Relating to Retail Method
• Freight costs
• Purchase returns
• Purchase discounts and allowances
• Transfers-in
• Normal shortages
• Abnormal shortages
• Employee discounts
When sales are recorded
gross, companies do not
recognize sales discounts.

Conventional Retail Inventory Method
—Special Items Included
ILLUSTRATION 9.22

Evaluation of Retail Inventory Method
Used for the following reasons:

1) To permit the computation of net income without a physical
count of inventory.
2) Control measure in determining inventory shortages.
3) Regulating quantities of merchandise on hand.
4) Insurance information.
Some companies refine the retail method by computing inventory
separately by departments or class of merchandise with similar
gross profits.

Explain how to report and analyze
inventory.

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.

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.

Analysis of Inventories
Common ratios used in the management and evaluation of

inventory levels are inventory turnover and average days to
sell the inventory.

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

Average Days to Sell Inventory
Measure represents the average number of days’ sales for which a
company has inventory on hand.
ILLUSTRATION 9.25

Compare the accounting for inventories
under IFRS and U.S. GAAP.

Global Accounting Insights
Inventories
In most cases, IFRS and U.S. GAAP related to inventory are the
same. The major differences are that I FRS prohibits the use of
the LIFO cost flow assumption and records market in the L CN
RV differently.

Similarities
• U.S. GAAP and IFRS account for inventory acquisitions at

historical cost and evaluate inventory for lower-of-cost-or-net
realizable value (market) subsequent to acquisition.
• Who owns the goods—goods in transit, consigned goods, special
sales agreements—as well as the costs to include in inventory are
essentially accounted for the same under U.S. GAAP and IFRS.

Differences
• U.S. GAAP provides more detailed guidelines in inventory accounting. The
requirements for accounting for and reporting inventories are more principles-based
under IFRS.
• A major difference between U.S. G AAP and IFRS relates to the LIFO cost flow
assumption. U.S. GAAP permits the use of L IFO for inventory valuation. IFRS
prohibits its use. FIFO and average-cost are the only two acceptable cost flow
assumptions permitted under I FRS. Both sets of standards permit specific
identification where appropriate.
• In the lower-of-cost-or-market test for inventory valuation, U.S. G AAP defines market
as replacement cost subject to the constraints of net realizable value (the ceiling)
and net realizable value less a normal markup (the floor) for inventories accounted
for under LIFO or retail inventory methods. IFRS defines market as net realizable
value and does not use a ceiling or a floor to determine market.

More Differences
• Under U.S. GAAP, if inventory is written down under the lower-of-cost-

or-market valuation, the new basis is now considered its cost. As a result,
the inventory may not be written up back to its original cost in a
subsequent period. Under IFRS, the write-down may be reversed in a
subsequent period up to the amount of the previous write-down. Both
the write-down and any subsequent reversal should be reported on the
income statement.
• IFRS requires both biological assets and agricultural produce at the point
of harvest to be reported at net realizable value. U.S. GAAP does not
require companies to account for all biological assets in the same way.
Furthermore, these assets generally are not reported at net realizable
value. Disclosure requirements also differ between the two sets of
standards.

On the Horizon
One convergence issue that will be difficult to resolve relates to the

use of the LIFO cost flow assumption. As indicated, IFRS specifically
prohibits its use. Conversely, the LIFO cost flow assumption is
widely used in the United States because of its favorable tax
advantages. In addition, many argue that LIFO from a financial
reporting point of view provides a better matching of current costs
against revenue and therefore enables companies to compute a
more realistic income.

About the Numbers
U.S. GAAP Inventory, Presentation and Disclosures
ILLUSTRATION GAAP 9.1

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Intermediate Accounting

After studying this chapter, you should be able to:

Copyright ©2020 John Wiley & Sons, Inc. 2

Copyright ©2020 John Wiley & Sons, Inc. 3

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 4

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 5

Illustration: Assume that Mander AG has unfinished inventory with a cost

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 7

Jinn-Feng Foods computes its inventory at LCNRV (amounts in

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 8

• In most situations, companies price inventory on an item-

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 9

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 10

Illustration: Data for Ricardo SpA

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 11

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 12

Instead of crediting the Inventory account for NRV adjustments,

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 13

Allowance to Reduce Inventory to NRV 4,000

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 14

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 15

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 16

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 17

Item Cost Net Realizable Value* Lower-of-Cost-or-NRV

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 18

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 19

Departure from LCNRV rule may be justified in situations

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 20

Biological asset (classified as a non-current asset) is a living

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 21

Agricultural produce is the harvested product of a biological

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 22

Illustration: Bancroft Dairy produces milk for sale to local cheese

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 23

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 24

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 25

Assuming the milk harvested in January was sold to a local cheese

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 26

Generally measure their inventories at fair value less costs to

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 27

Used when buying varying units in a single lump-sum

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 28

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 29

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 30

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 31

Illustration: When Apres cuts the timber at a cost of €10

Assume that Galling Land Ltd. permits Apres to reduce its

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 32

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 33

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 34

Illustration: Cetus SE has a beginning inventory of €60,000 and

Illustration: In Illustration 9.13, the gross profit was a given. But

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 36

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 37

E9.14 Astaire ASA uses the gross profit method to estimate

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 39

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 40

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 42

Method used by retailers to compile inventories at retail prices.

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 43

Markup—an additional markup of the original retail price.

LO 4 Copyright ©2020 John Wiley & Sons, Inc. 44

Conventional Retail Method—Computes a ratio after net markups