Diane Company, a retailer and wholesaler of national brand-name household lighti

Question

Diane Company, a retailer and wholesaler of national brand-name household lighting and fixtures, purchases its inventories from various suppliers.

Required:

(a) What criteria are used to determine which of Diane’s costs are inventoriable? (b) Are Diane’s administrative costs inventoriable?
(a) Diane uses the lower of cost or market rule for its wholesale inventories. Explain the theoretical arguments for that rule. (b) The replacement cost of the inventories is below the net realizable value less a normal profit margin, which, in turn, is below the original cost. Explain the amount that is used to value the inventories.
Diane calculates the estimated cost of its ending inventories held for sale at retail using the conventional (lower of average cost or market) retail inventory method. Explain how Diane would treat the beginning inventories and net markdowns in calculating the cost ratio used to determine its ending inventories.

Explanation / Answer

1. a) Diane's inventoriable costs includes all costs incurred to get the lighting fixtures ready for sale to the customer. It includes not only the purchase price of the fixtures but also the other associated costs incurred on the fixtures up to the time they are ready for sale to the customer, for example, trnasportation in. b) No, administration costs are assumed to expire with the passage of time and not to attach to the product. Furthermore, administrative costs do not relate directly to inventories, but are incurred for the benefit of all functions of the business. 2. a) The lower of cost or market rule is used for valuing inventories because of the concept of balance sheet conservatism and because the decline in the utility of the inventories below its cost is recognized as a loss in the current period. b) The net realizable value less a normal profit margin is used to value the inventories because market cannot be less than net realizable value less a normal profit margin. To carry the inventories at net realizable value less a normal profit margin provides a means of measuring residual usefulness of an of an inventory expenditure. 3. Diane's beginning inventories at cost and at retail are included in the calculation of cost ratio. Net markdowns are excluded from the calculation of cost ratio.This procedure reduces the cost ratio because there is a larger denominator for the cost ratio. Thus the concept of balance sheet conservatisn is being followed.

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