Question

Intermediate 1 Terry Part #5: Chapter 9

To practice correcting the financial statements for the Lower of Cost or Market.

Information:

Terry's internal auditor is afraid that some inventory has become obsolete. She has gathered the following information about the inventory items she is worried about:

Inventory Items	Historical Cost	Current Sales Price	Disposal Cost	Replacement Value
TGIT	$20.00	$25.00	$7.15	$22.00
TT9G5	$25.00	$30.00	$6.90	$29.00

After talking with the Sales Department, she estimates that the normal markup on TGIT would be $8 and $12 on TT9G5. They currently have 60,000 units of TGIT and 90,000 units of TT9G5 in stock. Terry’s management has opted to record the loss, if any, to COGS and directly reduce inventory.

Terry’s management would like to know the effect of the sale on the Inventory Turnover (COGS / average total inventory)

Assignment:

1. Calculate the Inventory Turnover Ratio before you make any adjustments. Also calculate the average days in inventory for Terry’s overall inventory (before you make any adjustments).
2. Make the appropriate journal entries, if any, to correct for the change in inventory values due to a Lower of Cost or Market adjustment (including any necessary changes to income tax expense). Hint: only COGS and Inventory will be affected. Update Income Tax Expense and Income Tax Payable to reflect the change in tax expense due to the change in COGS.
3. Make any necessary changes to the financial statements.
   • Update the Income Statement to reflect the updated COGS and income tax expense.
   • Update the Balance Sheet to reflect the updated inventory and income tax payable balances.
   • Update the operating section of the statement of cash flows so that the net increase/decrease in cash reconciles with the balance sheet.
4. Calculate the Inventory Turnover Ratio and average days in inventory after you make any adjustments.

Answer 1

Given data
Inventory Item	TGIT	TT9G5
Historical cost $	20	25
Current sales price $	25	30
Disposal cost $	7.15	6.9
Replacement value $	22	29
Normal markup $	8	12
Current stock in units	60,000	90,000
Inventory Turnover Ratio before adjustments =
Cost of Goods Sold/ Average Inventory
Cost of goods sold per unit = Selling Price - Normal markup
For TGIT, COGS =	25-8=	17
Total COGS = 17*60000 =	10,20,000
For TT9G5, COGS =	30-12=	18
Total COGS = 18*90000 =	16,20,000
Since data on opening and closing inventory is
not given, current stock will have to be taken as
average inventory.
So inventory turnover ratio for TGIT =
1020000/60000 =
17
So inventory turnover ratio for TT9G5 =
1620000/90000
18
Average days in inventory(in days) = Average inventory/
Cost of goods sold * 365
	TGIT	TT9G5
60000/1020000*365	21.47
90000/1620000*365		20.28

Calculation of amount to be written down to reflect
market value
	TGIT	TT9G5
Historical cost $	20	25
Current sales price $	25	30
Disposal cost $	7.15	6.9
Net realisable value $	17.85	23.1
Write down per unit	2.15	1.9
Units in stock	60,000	90,000
Total write down	1,29,000	1,71,000	3,00,000
Journal entry to record the adjustments
		Debit $	Credit $
Cost of Goods Sold account		3,00,000
To Inventory account			3,00,000
(Loss on write-down of inventories to net realisable value
recorded)
After making the adjustments the inventory turnover ratio
and average days in inventory are recalculated as below :-
		TGIT	TT9G5
Original COGS		10,20,000	16,20,000
Add : adjustment for write down		1,29,000	1,71,000
Revised COGS		11,49,000	17,91,000
Revised inventory turnover ratio
1149000/60000		19.15
1791000/90000			19.9
Revised average days in inventory
60000/1149000*365		19.06
90000/1791000*365			18.34