Valuation and Reporting of Receivables and Inventory

1
Valuation and Reporting of Receivables and
Inventory

• Chapter 6

2
Uncollectible Receivables

• The matching principle requires that the expense
  related to uncollectible receivables must be
  recorded in the same period as the related
  revenue
• Often requires an estimate of uncollectible
  receivables
• Sale may be made in one period, but the
  uncollectible receivable is not identified until
  a later period

3
Uncollectible Receivables

• Balance sheet presentation requires reporting of
  the estimated value of the receivables that will
  be collected (net realizable value)
• An allowance for doubtful accounts is used to
  estimate the amount of receivables that will not
  be collected
• Usually do not know which receivables will be
  uncollectible
• The allowance is offset against the receivable
  account

4
Uncollectible Receivables

• Estimation methods
• Percent of sales method
• Bad debt expense is calculated as a percent of
  credit sales made during the period
• The expense increases the allowance for doubtful
  accounts
• Percent of receivables method
• The required allowance for doubtful accounts is
  calculated as the percent of receivables that are
  expected to be uncollectible (aging)
• Bad debt expense is the amount required to bring
  the allowance up to its required balance

5
Uncollectible Receivables

• Recording bad debt expense at year-end increases
  the allowance account and reduces retained
  earnings
• It does not affect accounts receivable
• Writing off a customers account reduces accounts
  receivable and the allowance
• It does not affect bad debt expense
• Net realizable value of receivables is the same
  after the writeoff as it was before

6
Valuation of Inventory

• Inventory valuation relies on estimates since it
  is often impossible to determine exactly which
  goods have been sold and which remain in
  inventory
• Cost flow assumptions
• Specific identification
• Weighted average
• First-in, first-out (FIFO)
• Last-in, first-out (LIFO)

7
Valuation of Inventory

• Specific identification
• Can specifically identify which goods remain, and
  match them to their cost
• No estimate is needed
• Weighted average cost
• Determine the average cost of all goods available
  for sale
• Total cost / total units

8
Inventory Valuation

• First-in, first-out
• Assumes oldest goods are sold first, newer ones
  remain in inventory
• Assigns the oldest costs to the income statement
• May understate cost of merchandise sold
• Assigns the newest costs to the balance sheet
• Provides good estimate of replacement cost of
  inventory

9
Inventory Valuation

• Last-in, first-out
• Assumes newest goods are sold first, oldest ones
  remain in inventory
• Assigns most recent costs to the income statement
• Good matching of cost to revenue, except when old
  units are sold
• Assigns oldest costs to balance sheet
• May understate inventory value

10
Inventory Valuation

• Example

11
Inventory Valuation

• Weighted average cost
• 2,608 / 400 units 6.52 per unit
• Ending inventory
• 110 units _at_ 6.52 717.20
• Cost of merchandise sold
• 290 units _at_ 6.52 1,890.80

12
Inventory Valuation

• First-in, first-out
• Ending inventory
• Cost of merchandise sold

13
Inventory Valuation

• Last-in, first-out
• Ending inventory
• Cost of merchandise sold

14
Inventory Valuation

• Lower of cost or market rule
• Inventory is reported at cost unless
• The replacement cost is below the recorded cost,
  or
• The items cannot be sold at their normal selling
  price
• Cost, as determined by one of the cost flow
  assumptions, is compared to the market value
• Whichever is lower is the amount reported on the
  financial statements
• Avoids overstating the value of inventory