Intermediate I Chapter 9 (1)

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Chapter9-1

Inventories: AdditionalInventories: AdditionalValuation Issues Valuation Issues

Inventories: AdditionalInventories: AdditionalValuation Issues Valuation Issues

ChapterChapter99

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Chapter9-2

1.1. Describe and apply the lower-of-cost-or-market rule.Describe and apply the lower-of-cost-or-market rule.2.2. Explain when companies value inventories at net realizableExplain when companies value inventories at net realizable

value.value.3.3. Explain when companies use the relative sales value methodExplain when companies use the relative sales value method

to value inventories.to value inventories... Discuss accountin! issues related to purchase commitments.Discuss accountin! issues related to purchase commitments.

".". Determine endin! inventory by applyin! the !ross profitDetermine endin! inventory by applyin! the !ross profitmethod.method.

#.#. Determine endin! inventory by applyin! the retail inventoryDetermine endin! inventory by applyin! the retail inventorymethod.method.

$.$. Explain how to report and analyze inventory.Explain how to report and analyze inventory.

Learning Objectives Learning Objectives

Learning Objectives Learning Objectives

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Chapter9-3

Inventories: Additional Valuation Issues Inventories: Additional Valuation Issues

Inventories: Additional Valuation Issues Inventories: Additional Valuation Issues

Net realizableNet realizablevaluevalue

Relative salesRelative salesvaluevalue

PurchasePurchasecommitmentscommitments

Lower-of-Lower-of-Cost-or-Cost-or-MarketMarket

ValuationValuationBasesBases

Gross ProfitGross ProfitMethodMethod

RetailRetailIn entor!In entor!MethodMethod

PresentationPresentationand "nal!sisand "nal!sis

Ceiling andCeiling andfloor floor

How LCMHow LCMworksworks

Application of Application ofLCMLCM

Market!Market!

"valuation of"valuation ofrulerule

#ross profit#ross profitpercentagepercentage

"valuation of"valuation ofmethodmethod

ConceptsConcepts

ConventionalConventionalmethodmethod

$pecial items$pecial items

"valuation of"valuation of

methodmethod

PresentationPresentation

Anal%sis Anal%sis

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Chapter9-#

%arket & 'eplacement (ost)ower of (ost or 'eplacement (ost

)oss should be recorded when loss occurs* not in theperiod of sale.

+ company abandons the historical cost principle whenthe future utility ,revenue-producin! ability of the

asset drops below its ori!inal cost.

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

LCM

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Chapter9-$

Decline in the '( usually & decline in sellin! price.

'( allows a consistent rate of !ross profit.f reduction in '( fails to indicate reduction in utility*

then two additional valuation limitations are used/Ceiling - net realizable value and&loor - net realizable value less a normal profit mar!in.

0hy use 'eplacement (ost ,'( for %arket

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

Ceiling and &loor

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Chapter9-%

'ot'ot((

Cost

Cost Mar et

Mar et

Ceiling ) '*V

Ceiling ) '*V

*eplace$entCost

*eplace$entCost

&loor )'*V less 'or$al

+rofit Margin

&loor )'*V less 'or$al

+rofit Margin,AA+LCM

,AA+LCM

0hat is the rationale for the0hat is the rationale for the CeilingCeiling andand &loor&loor limitationslimitations

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

'ot'ot

llustration -3llustration -3

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Chapter9-&

Ceiling prevents overstatement of the value ofobsolete* dama!ed* or shopworn inventories.

&loor deters understatement of inventory andoverstatement of the loss in the current period.

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

*ationale for Li$itations

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Chapter9-'

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

.ow LCM /or s , ndividual tems

llustration -"llustration -"

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Chapter9-9

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

Methods of Appl#ing LCM

llustration -#llustration -#

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Chapter9-1( LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

*ecording LCM ,data from llus. -" and -#Endin! inventory ,cost 4 1"*555Endin! inventory ,)(% 3"5*555+d6ustment to )(% 4 #"*555

+llowance on inventory #"*555)oss on inventory #"*555

nventory #"*555(ost of !oods sold #"*555

+llowance%ethod

+llowance%ethod

Direct%ethodDirect

%ethod

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Chapter9-11 LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

0alance 1heet +resentation

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Chapter9-12

Allowance "irect

1ales 23343335 23343335Cost of goods sold !634333 !784333 ,ross profit !734333 !!84333

Operating e penses:1elling 84333 84333

,eneral and ad$inistrative 634333 634333 ;otal operating e penses

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Chapter9-13

7 -1 8rant 0ood (ompany manufactures desks. 9he companyattempts to obtain a 25: !ross mar!in on sellin! price. +tDecember 31* 255;* the followin! finished desks appear in thecompany

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Chapter9-1#

'ot'ot((

Cost ) ?3Cost ) ?3 Mar et ) 88Mar et ) 88

Ceiling ) 88=833 8>=833 8>

Ceiling ) 88=833 8>=833 8>

*eplace$entCost ) = 88-=833 63B>>

&loor ) 288= 88-=833 63B>>= 88-=833 63B>>

LCM ) 88LCM ) 88

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

'ot'ot

&inished "es s AInventor# cost ?35@st% cost to $anufacture

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Chapter9-1$

'ot'ot((

Cost ) 83Cost ) 83 Mar et ) 3Mar et ) 3

Ceiling ) 73=8 3 =8 3

Ceiling ) 73=8 3 =8 3

*eplace$entCost ) 3

*eplace$entCost ) 3

&loor ) 2?6= 73-=8 3 63B>>= 73-=8 3 63B>>

&loor ) 2?6= 73-=8 3 63B>>= 73-=8 3 63B>>

LCM ) 3LCM ) 3

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

'ot'ot

&inished "es s 0Inventor# cost 835@st% cost to $anufacture 3 Co$$issions and disposal costs

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Chapter9-1%

'ot'ot((

Cost ) 723Cost ) 723 Mar et )

Ceiling ) 7!3=933 93>=933 93>

*eplace$entCost )

*eplace$entCost )

&loor ) >=7!3-=933 63B>>

&loor ) >=7!3-=933 63B>>

LCM )

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Chapter9-1&

'ot'ot((

Cost ) 9

Ceiling ) !43?3=!4633 !23>=!4633 !23>

*eplace$entCost ) !4333*eplace$entCost ) !4333

&loor ) 723=!43?3-=!4633 63B>>=!43?3-=!4633 63B>>

&loor ) 723=!43?3-=!4633 63B>>=!43?3-=!4633 63B>>

LCM ) 9

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Chapter9-1'

Expense recorded when loss in utility occurs. 7rofit onsale reco!nized at the point of sale.

nventory valued at cost in one year and at market in thenext year.=et income in year of loss is lower. =et income in

subse>uent period may be hi!her than normal if expectedreductions in sales price do not materialize.)(% uses a ?normal profit@ in determinin! inventoryvalues* which is a sub6ective measure.

Aome Deficiencies/

Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et Lower-of-Cost-or-Mar et

LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%LO ! "escribe and appl# the lower-of-cost-or-$ar et rule%

@valuation of LCM *ule

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Chapter9-19

,1 a controlled market with a >uoted price applicable to

all >uantities* and,2 no si!nificant costs of disposal ,rare metals and

a!ricultural products

or,3 too difficult to obtain cost fi!ures ,meatpackin!

7ermitted by 8++7 under the followin! conditions/

Valuation 0ases Valuation 0ases Valuation 0ases Valuation 0ases

LO 6 @9plain when co$panies value inventories at net reali able value%LO 6 @9plain when co$panies value inventories at net reali able value%

'et *eali able Value

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Chapter9-2(

Bsed when buyin! varyin! units in a sin!le lump-sum purchase.

Valuation 0ases Valuation 0ases Valuation 0ases Valuation 0ases

LO 2 @9plain when co$panies use the relativeLO 2 @9plain when co$panies use the relativesales value $ethod to value inventories%sales value $ethod to value inventories%

*elative 1ales Value

E -$ ,'elative Aales Calue %ethod 7hil (ollins 'ealty (orporationpurchased a tract of unimproved land for 4""*555. 9his land was improvedand subdivided into buildin! lots at an additional cost of 43 * #5. 9hesebuildin! lots were all of the same size but owin! to differences in locationwere offered for sale at different prices as follows. peratin! expensesallocated to this pro6ect total 41;*255.

nstructions/ (alculatethe net income realizedon this operation todate.

'o% of +rice Lots Dnsold,roup Lots per Lot at Eear-@nd! 9 243335 86 !8 4333 ?2 !? 64 33 6

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Chapter9-21

Valuation 0ases Valuation 0ases Valuation 0ases Valuation 0ases

LO 2 @9plain when co$panies use the relativeLO 2 @9plain when co$panies use the relativesales value $ethod to value inventories%sales value $ethod to value inventories%

E -$ ,'elative Aales Calue %ethod - Aolution'o% of +rice 1elling *elative ;otal Cost Cost

,roup Lots per Lot +rice 1ales +rice Cost Allocated +er Lot! 9 243335 6?43335 56?4333F!6?4733 794

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Chapter9-22

8enerally seller retains title to the merchandise.

uyer reco!nizes no asset or liability.

f material* the buyer should disclose contract details infootnote.

f the contract price is !reater than the market price*and the buyer expects that losses will occur when the

purchase is effected* the buyer should reco!nize lossesin the period durin! which such declines in market pricestake place.

Valuation 0ases Valuation 0ases Valuation 0ases Valuation 0ases

LO "iscuss accounting issues related to purchase co$$it$ents%LO "iscuss accounting issues related to purchase co$$it$ents%

+urchase Co$$it$ents

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Chapter9-23

'elies on 9hree +ssumptions/

,ross +rofit Method ,ross +rofit Method ,ross +rofit Method ,ross +rofit Method

LO 8 "eter$ine ending inventor# b# appl#ing the gross profit $ethod%LO 8 "eter$ine ending inventor# b# appl#ing the gross profit $ethod%

1ubstitute Measure to Appro i$ate Inventor#

,1 e!innin! inventory plus purchases e>ual total !oods tobe accounted for.

,2 8oods not sold must be on hand.

,3 9he sales* reduced to cost* deducted from the sum ofthe openin! inventory plus purchases* e>ual endin!inventory.

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Chapter9-2#

E -12 ,8ross 7rofit %ethod %ark 7rice (ompany uses the!ross profit method to estimate inventory for monthlyreportin! purposes. 7resented below is information for themonth of %ay.

nstructions/,a (ompute the estimated inventory at %ay 31* assumin! that the !ross

profit is 35: of sales.,b (ompute the estimated inventory at %ay 31* assumin! that the !ross

profit is 35: of cost .

Inventor#4 Ma# ! !

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Chapter9-2$

E -12 ,8ross 7rofit %ethod - Aolution

=a> Inventor#4 Ma# ! =at cost> 5 ! =at cost> < 34333+urchase discounts =!64333>&reight-in 234333,oods available =at cost> 7!743331ales =at selling price> 5 !433343331ales returns =at selling price> =?34333>

'et sales =at selling price> 9234333Less gross profit =23B of 59234333> 6?943331ales =at cost> 5 !

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Chapter9-2%

=a> Inventor#4 Ma# ! =at cost> 5 ! =at cost> < 34333+urchase discounts =!64333>&reight-in 234333,oods available =at cost> 7!743331ales =at selling price> 5 !433343331ales returns =at selling price> =?34333>

'et sales =at selling price> 9234333Less gross profit =62%37B of 59234333> 6! 4<1ales =at cost> ?!8428<Appro i$ate inventor#4 Ma# 2! =at cost> 5 !364<

E -12 ,8ross 7rofit %ethod - Aolution,b (ompute the estimated inventory assumin! !ross profit is 35: of cost .

,ross +rofit Method ,ross +rofit Method ,ross +rofit Method ,ross +rofit Method

LO 8 "eter$ine ending inventor# b# appl#ing the gross profit $ethod%LO 8 "eter$ine ending inventor# b# appl#ing the gross profit $ethod%

23B

!33B G 23B) 62%37B of sales

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Chapter9-2&

Disadvanta!es/

,ross +rofit Method ,ross +rofit Method ,ross +rofit Method ,ross +rofit Method

LO 8 "eter$ine ending inventor# b# appl#ing the gross profit $ethod%LO 8 "eter$ine ending inventor# b# appl#ing the gross profit $ethod%

@valuation:

,1 7rovides an estimate of endin! inventory.

,2 Bses past percenta!es in calculation.

,3 + blanket !ross profit rate may not be representative.

, nly acceptable for interim ,!enerally >uarterly

reportin! purposes.

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Chapter9-2'

*etail Inventor# Method *etail Inventor# Method *etail Inventor# Method *etail Inventor# Method

LO < "eter$ine ending inventor# b# appl#ing the retail inventor# $ethod%LO < "eter$ine ending inventor# b# appl#ing the retail inventor# $ethod%

+ method used by retailers* to value inventory withouta physical count* by convertin! retail prices to cost.

,1 the total cost and retail value of !oods purchased*,2 the total cost and retail value of the !oods available

for sale* and

,3 the sales for the period.

'e>uires retailers to keep/

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Chapter9-29

7 -; ,'etail nventory %ethod Fared Fones nc. uses theretail inventory method to estimate endin! inventory for itsmonthly financial statements. 9he followin! data pertain to asin!le department for the month of ctober 255;.

*etail Inventor# Method *etail Inventor# Method *etail Inventor# Method *etail Inventor# Method

C)*+ R,+"ILBe . in entor!/ )0t. 1 $2/((( &'/(((Pur0hases 2%2/((( #23/(((

rei ht in 1%/%(( Pur0hase returns $/%(( '/((( "dditional arkups 9/(((

Markup 0an0ellations 2/((( Markdowns 4net5 3/%(( 6or al spoila e 1(/((( *ales 3'(/(((

Instructions: 7repare a schedulecomputin! estimateretail inventoryusin! the followin!

methods/,1 (ost,2 )(%,3 ) G ,appendix

LO < "eter$ine ending inventor# b# appl#ing the retail inventor# $ethod%LO < "eter$ine ending inventor# b# appl#ing the retail inventor# $ethod%

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Chapter9-3(

*etail Inventor# - Cost Method *etail Inventor# - Cost Method *etail Inventor# - Cost Method *etail Inventor# - Cost Method

LO < "eter$ine ending inventor# b# appl#ing the retail inventor# $ethod%LO < "eter$ine ending inventor# b# appl#ing the retail inventor# $ethod%

P9-' *olution - Cost Method Cost toC)*+ R,+"IL Retail 7

Be . in entor! $2/((( &'/(((Pur0hases 2%2/((( #23/(((

rei ht in 1%/%(( Pur0hase returns 4$/%((5 4'/(((5 Markdowns/ net 43/%((5 Markups/ net &/(((

Current !ear additions 2&3/((( #1'/#(( Goods a aila8le for sale 32$/((( #9%/#(( %$.#&7 6or al spoila e 41(/(((5

*ales 43'(/(((5 ,ndin in entor! at retail 1(%/#((

,ndin in entor! at Cost1(%/#(( : %$.#&7 ; %9/%%(

))FF

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Chapter9-31

*etail Inventor# - LCM Method *etail Inventor# - LCM Method *etail Inventor# - LCM Method *etail Inventor# - LCM Method

LO < "eter$ine ending inventor# b# appl#ing the retail inventor# $ethod%LO < "eter$ine ending inventor# b# appl#ing the retail inventor# $ethod%

P9-' *olution - LCM 4C)6V,6+I)6"L5 Method Cost toC)*+ R,+"IL Retail 7

Be . in entor! $2/((( &'/(((Pur0hases 2%2/((( #23/(((

rei ht in 1%/%((

Pur0hase returns 4$/%((5 4'/(((5 Markups/ net &/((( Current !ear additions 2&3/((( #22/(((

Goods a aila8le for sale 32$/((( $((/((( %$.((7 Markdowns/ net 43/%((5

6or al spoila e 41(/(((5

*ales 43'(/(((5 ,ndin in entor! at retail 1(%/#((

,ndin in entor! at Cost1(%/#(( : %$.((7 ; %9/1%(

))FF

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Chapter9-32

*etail Inventor# - LI&O Method *etail Inventor# - LI&O Method *etail Inventor# - LI&O Method *etail Inventor# - LI&O Method

LO 7 "eter$ine ending inventor# b# appl#ing the LI&O retail inventor# $ethods%LO 7 "eter$ine ending inventor# b# appl#ing the LI&O retail inventor# $ethods%

P9-' *olution - LI ) Method Cost toC)*+ R,+"IL Retail 7

Be . in entor! $2/((( &'/((( %%.%&7Pur0hases 2%2/((( #23/(((

rei ht in 1%/%(( Pur0hase returns 4$/%((5 4'/(((5 Markdowns/ net 43/%((5 Markups/ net &/(((

Current !ear additions 2&3/((( #1'/#(( %$.2$7Goods a aila8le for sale 32$/((( #9%/#((

6or al spoila e 41(/(((5 *ales 43'(/(((5

,ndin in entor! at retail 1(%/#((

,ndin in entor! at CostP< &'/((( : %%.%&7 ; $2/(((C< 2'/#(( : %$.2$7 ; 1'/$31

1(%/#(( &(/$31

))FF

))FF

+ppendix ++ppendix +

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Chapter9-33

0idely used for the followin! reasons/@valuation:

,1 to permit the computation of net income without a

physical count of inventory*,2 as a control measure in determinin! inventory

shorta!es*

,3 in re!ulatin! >uantities of merchandise on hand* and

, for insurance information.

*etail Inventor# Method *etail Inventor# Method *etail Inventor# Method *etail Inventor# Method

LO < "eter$ine ending inventor# b# appl#ing the retail inventor# $ethod%LO < "eter$ine ending inventor# b# appl#ing the retail inventor# $ethod%

Aome companies refine the retail method by computin! inventory separatelyby departments or class of merchandise with similar !ross profits.

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Chapter9-3#

+ccountin! standards re>uire disclosure of/

+resentation and Anal#sis +resentation and Anal#sis +resentation and Anal#sis +resentation and Anal#sis

LO ? @9plain how to report and anal# e inventor#%LO ? @9plain how to report and anal# e inventor#%

+resentation:

,1 composition of the inventory*

,2 financin! arran!ements* and,3 costin! methods employed.

(ommon ratios used in the mana!ement and evaluation ofinventory levels are inventory turnover and avera!e daysto sell the inventory .

Anal#sis:

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Chapter9-3$

%easures the number of times on avera!e a companysells the inventory durin! the period.

+resentation and Anal#sis +resentation and Anal#sis +resentation and Anal#sis +resentation and Anal#sis

LO ? @9plain how to report and anal# e inventor#%LO ? @9plain how to report and anal# e inventor#%

Inventor# ;urnover *atio

llustration -2#llustration -2#

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Chapter9 3%

%easure represents the avera!e number of days<sales for which a company has inventory on hand.

+resentation and Anal#sis +resentation and Anal#sis +resentation and Anal#sis +resentation and Anal#sis

LO ? @9 l i h t t d l# i t #%LO ? @9 l i h t t d l# i t #%

Average "a#s to 1ell Inventor#

3#" days H ; times & every ".# days

nventory 9urnover

+vera!e Days to Aell

llustration -2#llustration -2#