CHAPTE5 ACCOUNTING FOR INVENTORY.ppt

* * * * * * * * * * * * * * * * * * * * 5-* Lower of Cost or Market (LCM) Inventory must be reported at lower of cost or market. Applied three ways: separately to each individual item. to major classes or categories of assets. (3) to the whole inventory. Market is defined as current replacement cost (not sales price). Consistent withthe conservatismprinciple. 5-* Lower of Cost or Market (LCM) To illustrate lower of cost or market, assume The Mountain Bike Company has in ending inventory 100 t-shirts purchased at a cost of $14 each. ? 5-* 5-* LO 3 Explain how fraud can be avoided through inventory control. 5-* Fraud Avoidance in Merchandising Businesses Because inventory and cost of goods sold accounts are so significant, they are attractive targets for concealing fraud. Because of this, auditors and financial analysts carefully examine them for signs of fraud. 5-* If Ending Inventory is overstated then Cost of Goods Sold will be understated. 5-* If Cost of Goods Sold is understated, then Gross Margin is overstated. Resulting in overstatement of Net Income. 5-* Then, on the balance sheet Inventory is overstated and Retained Earnings is overstated. Q5-5 * * 5-* LO 4 Use the gross margin method to estimate ending inventory. 5-* Estimating the Ending Inventory Balance Many companies use the gross margin method to estimate the current period’s ending inventory. 5-* Calculate the expected gross margin ratio using prior period’s income statement. Multiply the expected gross margin ratio by the current period’s sales to estimate the amount of gross margin. Subtract the estimated gross margin from sales to estimate cost of goods sold. Subtract the estimated cost of goods sold from the amount of goods available for sale to estimate the ending inventory. The Gross Margin Method 5-* 5-* LO 5 Explain the importance of inventory turnover to a company’s profitability. 5-* Inventory Turnover Cost of Goods Sold Inventory This measures how quickly a companysells it