CHAPTER 9 Inventories: Additional Valuation Issues


After studying this chapter, you should be able to:

  1. Describe and apply the lower-of-cost-or-market rule.
  2. Explain when companies value inventories at net realizable value.
  3. Explain when companies use the relative sales value method to value inventories.
  4. Discuss accounting issues related to purchase commitments.
  5. Determine ending inventory by applying the gross profit method.
  6. Determine ending inventory by applying the retail inventory method.
  7. Explain how to report and analyze inventory.

Not What It Seems to Be

Investors need comparable information about inventory when evaluating a retailer's financial statements. To do so, investors need to determine what inventory method a retailer is using (FIFO, LIFO, average-cost, or a combination of methods) and then adjust the company to a common method. That is a good start. What investors often then do is compute relevant information about the company such as inventory turnover, number of days sales in inventory, gross profit rate, and liquidity measures such as the acid-test ratio. These calculations are critical. Inventory is a significant component of working capital and the gross profit resulting from sales of inventory is often viewed as the most important income component in measuring a retailer's progress. For example, consider the financial statements of Best Buy shown in the following table. Inventory comprises over 50 percent of current assets, and gross profit ...

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