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    Direct Method or Cost of Goods Sold Method

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    Na Dem Dolotallas
    The document discusses inventory valuation and accounting for inventory writedowns. It states that inventory should be measured at the lower of cost or net realizable value according to accounting standards. The net realizable value is estimated selling price less estimated costs to complete and dispose. Inventory writedowns are usually done on an item-by-item basis. There are two methods for accounting for writedowns - the direct method writes it off directly to cost of goods sold, while the allowance method uses an allowance account to present the writedown separately. The document also discusses accounting for purchase commitments, including recording losses if prices decline before purchase and gains if prices rise.

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    Direct Method or Cost of Goods Sold Method

    Uploaded by

    Na Dem Dolotallas
    267 views2 pages
    The document discusses inventory valuation and accounting for inventory writedowns. It states that inventory should be measured at the lower of cost or net realizable value according to accounting standards. The net realizable value is estimated selling price less estimated costs to complete and dispose. Inventory writedowns are usually done on an item-by-item basis. There are two methods for accounting for writedowns - the direct method writes it off directly to cost of goods sold, while the allowance method uses an allowance account to present the writedown separately. The document also discusses accounting for purchase commitments, including recording losses if prices decline before purchase and gains if prices rise.

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    Chapter_12_LCNRV

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    The document discusses inventory valuation and accounting for inventory writedowns. It states that inventory should be measured at the lower of cost or net realizable value according to accounting standards. The net realizable value is estimated selling price less estimated costs to complete and dispose. Inventory writedowns are usually done on an item-by-item basis. There are two methods for accounting for writedowns - the direct method writes it off directly to cost of goods sold, while the allowance method uses an allowance account to present the writedown separately. The document also discusses accounting for purchase commitments, including recording losses if prices decline before purchase and gains if prices rise.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    267 views2 pages

    Direct Method or Cost of Goods Sold Method

    Uploaded by

    Na Dem Dolotallas
    The document discusses inventory valuation and accounting for inventory writedowns. It states that inventory should be measured at the lower of cost or net realizable value according to accounting standards. The net realizable value is estimated selling price less estimated costs to complete and dispose. Inventory writedowns are usually done on an item-by-item basis. There are two methods for accounting for writedowns - the direct method writes it off directly to cost of goods sold, while the allowance method uses an allowance account to present the writedown separately. The document also discusses accounting for purchase commitments, including recording losses if prices decline before purchase and gains if prices rise.

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    III.

    LOWER OF COST AND NET REALIZABLE VALUE

    PAS 2, par 9, provides that inventories shall be measured at the LOWER of Cost or Net Realizable Value
    (LCNRV). The practice of writing inventories down below cost to net realizable value is consistent with the
    view that assets shall not be carried in excess of amounts expected to be realized from their sale or use.

    Net Realizable Value = Estimated Selling Price – Est. cost of completion – Est. cost of disposal

    Inventories are usually written down to net realizable value on an item by item or individual basis.

    Accounting for Inventory Writedown:


    Cost < NRV = The inventory is measured at cost and the increase in value is not recognized
    NRV < Cost = The inventory is measured at NRV and the decrease in value is recognized

    Methods of accounting for inventory writedown


    a. Direct method or cost of goods sold method
    b. Allowance Method or Loss method (Preferred method, supported by PAS 2,par 36)

    *Note that whether direct writeoff method or allowance method, the cost of goods sold must be the same.

    Direct method or cost of goods sold method


    The inventory is recorded lower of cost or net realizable value. Any loss on inventory writedown is
    not accounted separately but “buried” in the cost of goods sold.

    Inventory – end xx
    Income summary xx

    Allowance method or loss method


    The inventory is recorded at COST and any loss on inventory writedown is accounted for separately.
    Loss on inventory writedown = COST > NRV

    Entry:
    Loss on inventory writedown xx
    Allowance for inventory writedown xx

    The allowance account is adjusted at every end of the year. If the required allowance increases, an additional
    loss is recognized. If the required allowance decreases, a gain on reversal of inventory writedown is recorded.
    However, the gain is limited only to the extent of the allowance balance.

    Entry: If there is increase in the required allowance


    Loss on inventory writedown xx
    Allowance for inventory writedown xx

    Entry: If there is decrease in the required allowance

    Allowance for inventory writedown xx


    Gain on reversal of inventory writedown xx

    Loss on inventory writedown account – included in the computation of cost of goods sold.

    Allowance for inventory writedown account – is presented as deduction from the inventory recorded at COST.

    Gain on reversal of inventory writedown account – is presented as the deduction from cost of goods sold (PAS
    2, par 34).
    Purchase Commitments
    - Are obligations of the entity to acquire certain goods sometimes in the future at a fixed price and
    fixed quantity. Note that Purchase Commitments must be NONCANCELABLE.
    - If there is decline in purchase price after a purchase commitment has been made, a loss is recorded
    in the period of price decline.
    Loss on purchase commitment xx
    Estimated Liability for purchase commitment xx
    Loss on purchase commitment account is classified as OTHER EXPENSE
    Estimated Liability for purchase commitment account is classified as CURRENT LIABILITY

    - If the market price rises by the time the entity makes the purchase, a gain on purchase
    commitment would be recorded. However, the amount of gain to be recognized is limited to the
    loss on purchase commitment previously recorded. Gain on purchase commitment account is
    classified as OTHER INCOME.

    Entry for actual purchase if there is additional loss:


    *Purchases xx
    Loss on purchase commitment xx
    Estimated liability for purch. comm xx
    **Accounts Payable xx

    Entry for actual purchase if there is gain:


    *Purchases xx
    Estimated liability for purch. comm xx
    **Accounts Payable xx
    Gain on purch. comm xx

    * Amount is Lower between the fixed price and replacement cost(Actual cost of Purhase)
    ** Amount to be recorded is the fixed price based on the purchase commitment/agreement.

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