Question

Judgment Case 9-1 Inventoriable costs; lower of cost or market; retail inventory method LO9-1 , LO9-3 , LO9-4 Hudson Company, which is both a wholesaler and a retailer, purchases its inventories from various suppliers. Additional facts for Hudson's wholesale operations are as follows: a. Hudson incurs substantial warehousing costs. b. Hudson values inventory at the lower of cost or market. Market is below cost of the inventories Additional facts for Hudson's retail operations are as follows: a. Hudson determines the estimated cost of its ending inventories held for sale at retail using the conventional retail inventory method, which approximates lower of average cost or market. b. Hudson incurs substantial freight-in costs. c. Hudson has net markups and net markdowns.

PLease provide a 500 words reply.

Answer 1

Part 1

Considering the matching principle of accounting, it would be appropriate for Hudson to record warehousing costs as a part of inventory. Every cost that is related to create finished goods inventory for sale should be the part of inventory cost. Warehousing costs are also referred as an indirect cost to produce finished goods. Thus according to matching principle, it will be possible to verify warehousing costs with the revenue when the finished goods are sold. Also, it is advisable to use retail inventory method to verify inventory expenses and their retail price.

Part 2 A

As per the principle of conservatism, the overstatement of assets on the balance sheet is not supported. Therefore, the inventory is reported at actual cost or market value, whichever is lower. The lower of cost or market method is mostly used when the inventory is held for the longer period of time and during that period it experiences market volatility. The inventory is supposed to be depreciated like other assets in the long run and thus this method generates a more realistic estimate of future cash flows to be realized from inventory in the future.

Part 2 B

It is important to get fair market value by determining the replacement value of the inventory. If the fair market value is greater than the actual cost, the inventory will be recorded at the actual cost. Whereas if the fair market value is lower than the actual cost, the inventory will be recorded at the fair market value. Here for Hudson, the fair market value or replacement cost is lower and thus inventory are to be reported at the replacement costs. In that case, Hudson would require to make an adjusting entry to present low value on the balance sheet.

Part 3 A

Freight-in costs is added in the cost amount. It is used in the calculation of cost-to-retail percentage. The cost to retail percentage increases due to it.

Part 3 B

Net markups is added in the retail amount. There is decrease in cost-to-retail percentage due to it.

Part 3 C

Net downs is added to the retail amount or excluded. There is increase in cost-to-retail percentage if it is added. There is lower cost-to-retail percentage if it is not deducted from the retail amount.

Part 4

Hudson's retail inventory method approximate lower of average cost and net realizable value as it has not subtracted net markdowns from the retail amount to calculate the cost-to-retail percentage. It gets lower cost-to-retail percentage compared to the cost-to-retail percentage derived after the deducting net markdowns. If the cost-to-retail percentage is low, then it will give the amount below cost and this is near to approximation.