Intermediate Accounting (acc 381)

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ResearchCase 2 – 25 points Spring 2013

This assignment is due on Tuesday, April 16, 2012 9:00 a.m. to the D2L drop box. A late assignment will not be graded. In other words, a late assignment is worth 0/25 points.

You must also bring a paper copy of your assignment to class on Tuesday, April 16.

You must use Microsoft Word to complete your assignment. Put a heading and your name on the document so that when I open it for grading I don’t have to guess who or what.

Submit your file saved with the following file name: lastname_firstname_case2. For example, my file name would be portz_kris_case2

When asked to cite the FASB Codification database, make sure you reference the database correctly, using a four number reference. For example: 835 – 20 – 30 – 2 (topic – subtopic – section – paragraph). While you are expected to cite the Codification in this assignment, you may use other resources to help you answer the questions.

TOPIC:

1. What is the meaning of cost as it applies to the initial measurement of inventory? Copy and paste the appropriate paragraph(s) from the Codification and provide the reference.

2. What is the major objective of accounting for inventory? Copy and paste the appropriate paragraph(s) from the Codification and provide the reference.

3. Brilliant Drilling is a manufacturer of drill bits for large oil rigs that operate around the world. A major component in the manufacturing of the drill bits is diamonds. As a result of an increase in oil drilling due to the increase in oil prices, Brilliant Drilling has received, and is expected to receive, an increase in orders for new and replacement drill bits. With such a potential demand, Brilliant Drilling has purchased a large quantity of diamonds. Since diamonds are considered a precious metal, Brilliant Drilling is contemplating the proper valuation of its inventory, which is currently above cost. Management has concluded that precious metals with a fixed monetary value and without substantial marketing costs can be recorded at market value, as discussed at a recent oil and gas conference that Brilliant’s accounting staff attended. Is that correct? Using the Codification, determine the proper valuation of the diamond inventory. Explain your answer thoroughly. Provide specific authoritative reference (s) from the Codification.

4. Top Notch Tires is a wholesaling and retailing company that deals in automotive tires for foreign cars. During the year-end audit, heated discussion occurs between management and the independent auditors. Management’s accounting policy for valuing inventory of imported tires reads as follows:

Inventory is valued at actual cost plus any freight-in. At year-end, the warehousing costs related to the tires are prorated to cost of goods sold and inventory on hand.

The auditors for Top Notch Tires believe that any warehousing costs should not be considered as inventory, but should be expensed as period costs. Management disagrees by stating that the warehousing costs would not have been incurred if the tires did not exist and therefore should be part of the value of the inventory on hand. The CFO of the company has requested the auditors to justify their conclusion by providing specific authoritative support for their decision. Utilize the Codification to provide a recommendation to the auditors to support their decision. Provide specific Codification reference (s).

5. Instant Cash is a company that manufactures and sells automated tell machines (ATM’s). From 2010 to 2012, Instant Cash management “wrote up” the value of certain used ATM machines. These write-ups had the effect of reducing the cost of goods sold and were used to meet forecasts. For example, in the second quarter of 2011, Instant Cash wrote up the value of its used equipment inventory by $1 million (and thus increased net income by $1 million) to help earnings meet forecasts. An accounting manager wrote,

The primary reason we needed to book the used equipment valuation was due to the overall corporate tax rate being a little higher than that which was forecasted. The tax rate change resulted in an approximate $500K problem in Net Income. As a result, we need a little more NIBT (net income before taxes) to deliver the required Net Income.

In another example, in the fourth quarter of 2010, Instant Cash wrote up the value of parts contained in some used ATMs by $650,000. Tellingly, these parts were never removed from the ATMs, and the ATMs were later scrapped. Furthermore, Instant Cash wrote up the value of other used equipment inventory by $750,000 in the fourth quarter of 2011 and $1.2 million in the first quarter of 2012. How should Instant Cash value its used equipment inventory? Include specific authoritative reference (s) from the Codification to support your answer.

6. If a decline in inventory value is due to seasonal price fluctuations, must inventory at the interim date be written down to lower of cost or market? Include specific authoritative reference (s) from the Codification to support your answer.

7. Assume that a company has inventory of 10,000 units carried at a purchase price of $24 per unit ($240,000). The company expects to sell the units at a price of $30 per unit. The company has estimated that the cost to sell the units amounts to 10% of the selling price, and the normal profit margin is 20% of the selling price. At the end of the first quarter or 2012, the cost to replace the 10,000 units is determined to be $22 per unit. This decrease in value from $24 to $22 per unit is assumed to represent a permanent decline in value.

a. What is the lower of cost or market per unit? Show all of your calculations. Provide the appropriate reference(s) from the Codification to support your answer.

b. Prepare the journal entry to record the permanent decline in inventory value.

c. Should this loss be recognized in the interim period or deferred to the end of the year? Provide specific Codifications reference (s) to support your answer.

d. Assume that, at the end of the fourth quarter of 2012, the 10,000 units were not sold and the cost to replace the units rose from $22 to $24.50. Assuming no change in the expected selling price, cost to sell, and normal profit margin, should the gain in market value be recognized? Provide specific Codification (s) references to support your answer. If so, prepare the appropriate journal entry.

8. Find the 2011 annual report (10-K SEC filing filed on 2/21/12) for Caterpillar on the Internet.

a. Fill in the table below with the appropriate dollar amounts obtained from the annual report.

2011	2010	2009
Inventory, Ending
Cost of Goods Sold
LIFO Reserve

b.

What would Inventory, Ending be in 2011 if FIFO had been used for inventory valuation?

c. What would COGS be in 2011 if FIFO had been used for inventory valuation?

d. Compute the ratio of LIFO inventory/FIFO inventory for 2011 ending inventory. Comment on the resulting number; explain the meaning of the ratio.

e. One of the major differences between US GAAP and IFRS as it relates to inventory is that LIFO is not allowed under IFRS. Companies using LIFO argue that if LIFO was eliminated as an option, they would face a large tax bill. Caterpillar reports an effective tax rate of 26.5%. Assume Caterpillar makes a switch from LIFO to FIFO and a single payment is made to the IRS on the day of the switch, what would the tax bill be for Caterpillar?

FASB Codification Research Case 2

Kris Portz

ACCT 381, 9:30

1. What is the meaning of cost as it applies to the initial measurement of inventory? Copy and paste the appropriate paragraph(s) from the Codification and provide the reference.

Your answer here

2. What is the major objective of accounting for inventory? Copy and paste the appropriate paragraph(s) from the Codification and provide the reference.

Your answer here