C H A P T E R

8

VALUATION OF I NVE NTOR I E S : A COST-BASIS APPROAC H

LEARNING OBJECTIVES
After studying this chapter, you should be able to:
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Identify major classifications of inventory. Distinguish between perpetual and periodic inventory systems. Identify the effects of inventory errors on the financial statements. Understand the items to include as inventory cost. Describe and compare the cost flow assumptions used to account for inventories. Explain the significance and use of a LIFO reserve. Understand the effect of LIFO liquidations. Explain the dollar-value LIFO method. Identify the major advantages and disadvantages of LIFO. Understand why companies select given inventory methods.

Inventories in the Crystal Ball

A substantial increase in inventory may be a leading indicator of an upcoming decline in profit margins. Take the auto industry as an example. Detroit’s inventories have been growing for several years because the domestic manufacturers like to run the factories at full capacity, even if they are not selling cars as fast as they can make them. The current arrangement is particularly tough for General Motors. It overproduces and then tries to push the sales with incentives and month-long “blow-out” sales. GM is hoping that the ever-growing market will cover the problem until customer demand grows to the point where the cars are purchased without so many incentives. But recently, all that was growing was GM inventories. A slowing economy and rising gas prices have scared car buyers from the new car lots, especially the sections with lowgas-mileage, full-size vehicles and SUVs. Not surprisingly, GM and other automakers have responded with discounted prices. For example, the average sticker on a Cadillac DeVille was $54,193, but the net price after incentives was $42,211. This meant that the factory was