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Chapter 9: Q5CA. (page 489)

Saurez Company, your client, manufactures paint. The company鈥檚 president, Maria Saurez, has decided to open a retail store to sell Saurez paint as well as wallpaper and other supplies that would be purchased from other suppliers. She has asked you for information about the conventional retail method of pricing inventories at the retail store. Instructions Prepare a report to the president explaining the retail method of pricing inventories. Your report should include the following points. (a) Description and accounting features of the method. (b) The conditions that may distort the results under the method. (c) A comparison of the advantages of using the retail method with those of using cost methods of inventory pricing. (d) The accounting theory underlying the treatment of net markdowns and net markups under the method.

Short Answer

Expert verified

The different points of the retail inventory method are given in the following steps.

Step by step solution

01

Description and accounting features

(a) Under the retail inventory method, retailers use a formula to convert the selling price to the cost price. It requires the retailers to maintain proper record cost and retail price of goods purchased and sold and the sales for the current period. Ending inventory value is valued at the retail price using the cost-to-retail ratio. It is estimated by subtracting sales revenue from the sum of beginning inventory and purchases and valuing the ending inventory on the basis of the cost-to-retail ratio.

02

 Step2: Conditions that may distort

(b) Conditions are as follows:

  • Incorrect estimation of the cost-to retail ratio
  • Incorrect calculation of markups and markdowns
  • Ineffective internal control related to inventory
03

Advantages of retail inventory method

(c) Advantages are as follows:

  • The ending value of the inventory can be estimated without m maintaining the proper record.
  • Loss due to fire or any other accident can be estimated easily.
  • Interim financial statements can be prepared easily.
04

Treatment of net markup and net markdown

Under this method, net markups are added to the sum of beginning inventory and net purchases at retail. Then this total value is used to calculate the cost-to-retail ratio. And then, the net markdown is subtracted to estimate the sale price of goods available.

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Most popular questions from this chapter

Barrick Gold Corporation, with headquarters in Toronto, Canada, is the world鈥檚 most profitable and largest gold mining company outside South Africa. Part of the key to Barrick鈥檚 success has been due to its ability to maintain cash flow while improving production and increasing its reserves of gold-containing property. In the most recent year, Barrick achieved record growth in cash flow, production, and reserves. The company maintains an aggressive policy of developing previously identified target areas that have the possibility of a large amount of gold ore, and that have not been previously developed. Barrick limits the riskiness of this development by choosing only properties that are located in politically stable regions, and by the company鈥檚 use of internally generated funds, rather than debt, to finance growth. Using Your Judgment 491 492 Chapter 9 Inventories: Additional Valuation Issues Barrick鈥檚 inventories are as follows. Barrick Gold Corporation Inventories (in millions, US dollars) Current Gold in process \(133 Mine operating supplies 82 \)215 Non-current (included in Other assets) Ore in stockpiles \(65 Instructions (a) Why do you think that there are no finished goods inventories? Why do you think the raw material, ore in stockpiles, is considered to be a non-current asset? (b) Consider that Barrick has no finished goods inventories. What journal entries are made to record a sale? (c) Suppose that gold bullion that cost \)1.8 million to produce was sold for $2.4 million. The journal entry was made to record the sale, but no entry was made to remove the gold from the gold in process inventory. How would this error affect the following? Balance Sheet Income Statement Inventory ? Cost of goods sold ? Retained earnings ? Net income ? Accounts payable ? Working capital ? Current ratio ?

You have been asked by the financial vice president to develop a short presentation on the LCNRV method for inventory purposes. The financial VP needs to explain this method to the president because it appears that a portion of the company鈥檚 inventory has declined in value. Instructions The financial vice president asks you to answer the following questions. (a) What is the purpose of the LCNRV method? (b) What is meant by 鈥渘et realizable value鈥�? (c) Do you apply the LCNRV method to each individual item, to a category, or to the total of the inventory? Explain. (d) What are the potential disadvantages of the LCNRV method?

Olson Corporation, a retailer and wholesaler of national brand-name household lighting fixtures, purchases its inventories from various suppliers. Instructions (a) (1) What criteria should be used to determine which of Olson鈥檚 costs are inventoriable ? (2) Are Olson鈥檚 administrative costs inventoriable ? Defend your answer. (b) (1) Olson uses the lower-of-cost-or-market rule for its wholesale inventories. What are the theoretical arguments for that rule? (2) The replacement cost of the inventories is below the net realizable value less a normal profit margin, which, in turn, is below the original cost. What amount should be used to value the inventories? Why? (c) Olson calculates the estimated cost of its ending inventories held for sale at retail using the conventional retail inventory method. How would Olson treat the beginning inventories and net markdowns in calculating the cost ratio used to determine its ending inventories? Why.

Sedato Company follows the practice of pricing its inventory at LCNRV, on an individual-item basis. Item No. Quantity Cost per Unit Estimated Selling Price Cost to Complete and Sell 1320 1,200 \(3.20 \)4.50 $1.60 1333 900 2.70 3.40 1.00 1426 800 4.50 5.00 1.40 1437 1,000 3.60 3.20 1.35 1510 700 2.25 3.25 1.40 1522 500 3.00 3.90 0.80 1573 3,000 1.80 2.50 1.20 1626 1,000 4.70 6.00 1.50 Instructions From the information above, determine the amount of Sedato Company inventory

You are called by Tim Duncan of Spurs Co. on July 16 and asked to prepare a claim for insurance as a result of a theft that took place the night before. You suggest that an inventory be taken immediately. The following data are available. Inventory, July 1 \( 38,000 Purchases鈥攇oods placed in stock July 1鈥�15 85,000 Sales revenue鈥攇oods delivered to customers (gross) 116,000 Sales returns鈥攇oods returned to stock 4,000 Your client reports that the goods on hand on July 16 cost \)30,500, but you determine that this figure includes goods of $6,000 received on a consignment basis. Your past records show that sales are made at approximately 40% over cost. Duncan鈥檚 insurance covers only goods owned. Instructions Compute the claim against the insurance company.
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