Question

Some circumstances justify departures from the historical cost approaches of FIFO, LIFO, and weighted average cost. Several additional inventory methods may be used when circumstances warrant. Identify and describe each of these alternative methods. Include an example of when each method may be applied. o Identify which methods could be used to determine whether there has been shrinkage or shortage in the physical inventory.

Answer 1

1.)Lower-of-cost-or-market (LCM) method is an inventory costing method that values inventory at the lower of its historical cost or its current market (replacement) cost. The LCM rule can be applied to inventory on individual items basis, inventory class basis or to entire inventory.

Example: Company A owns an item of inventory having original cost of $900. Its replacement cost is $880. Since the replacement cost of $880 lies within the limits set by LCM rule, it is allowable market value of the inventory.

2.Gross margin method estimates ending inventory by deduction estimated cost of goods sold from cost of goods available for sale. This method assumes that a fairly stable relationship exists between gross margin and net sales.

Example: For several years Company A has maintained a 30% gross margin on net sales. The following data for 2010 is available: January 1 inventory was USD 40,000; net cost of purchase of
merchandise was USD 480,000; and net sales of merchandise were USD 700,000. Field can estimate the inventory for 2010 December 31, by deducting the estimated cost of goods sold from the actual cost of goods available for sale.

3.Retail inventory method estimates the cost of the ending inventory by applying a cost/retail price ratio to ending inventory stated at retail prices. The advantage of this method is that companies can estimate ending inventory (at cost) without taking a physical inventory.