Chapter 7: Inventory
Too Much Inventory
BlackBerry Ltd. faced a rough week in late September 2013. Within a seven-day period, the company not only announced a potential buyer for the company but also reported a quarterly loss of close to a billion dollars. The loss was generated primarily by write-down of BlackBerry 10 handsets (BB 10), the company's new flagship product. Prior to this result, the company had been struggling to keep up with other smartphone competitors, and sales of the new phone had not met expectations. As a result of the news reported during this week, the company's share price fell over 20 percent on the market.
When the company reported its annual financial results for the year ended March 1, 2014, the gross profit on hardware sales was actually negative. In fact, it was – $2.5 billion. How can a company report a negative gross profit? In BlackBerry's case, a further write-down of the BB 10 handset occurred in the third quarter, resulting in total write-downs for the year of approximately $2.4 billion. As described in the company's Management Discussion and Analysis of Financial Condition report, evaluations of inventory require an assessment of future demand assumptions (BlackBerry Ltd., 2014). Sales of the new BlackBerry product were significantly lower than expected, resulting in a large number of unsold handsets. As the goal of financial reporting is to portray the economic truth of a company, BlackBerry Ltd. had no choice but to accept the reality that their inventory of BB 10 phones could not be sold for the amount reported on the balance sheet. The company described the causes of the write-down as these: the maturing smartphone market, very intense competition, and uncertainty created by the company's strategic review process.
Regardless of the causes, it was clear that this massive write-down had a profound effect on BlackBerry Ltd.'s financial results and share price. Although the write-down was a symptom of other deeper problems in the company, it is clear that management of inventory levels can be a significant issue for many businesses. For the accountant, understanding the importance of the reported inventory amount is paramount, and critically analyzing the valuation assumptions is essential to fair reporting of inventory balances.
(Sources: BlackBerry Ltd., 2014; Damouni, Kim & Leske, 2013)
After completing this chapter, you should be able to:
- Define inventory and identify those characteristics that distinguish it from other assets.
- Identify the types of costs that should be included in inventory.
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Identify accounting issues and treatments applied to inventory subsequent to its purchase.
- Describe the differences between periodic and perpetual inventory systems.
- Identify the appropriate criteria for selection of a cost flow formula and apply different cost flow formulas to inventory transactions.
- Determine when inventories are overvalued and apply the lower of cost and net realizable value rule to write-down those inventories.
- Describe the presentation and disclosure requirements for inventories under both IFRS and ASPE.
- Identify the effects of inventory errors on both the balance sheet and income statement and prepare appropriate adjustments to correct the errors.
- Calculate estimated inventory amounts using the gross profit method.
- Calculate gross profit margin and inventory turnover period and evaluate the significance of these results with respect to the profitability and efficiency of the business's operations.
- Identify differences in accounting for inventories between ASPE and IFRS.
Introduction
The nature of economic activity has been evolving rapidly over the last two decades. The knowledge economy is becoming an increasingly significant component of the world's gross domestic product. But even in the wired world of services and data, there is always a need for physical products. The concept of retail business may be changing through the development of online shopping, but consumers still expect to receive their goods eventually. This chapter will deal with some accounting issues surrounding the acquisition, production, and sale of inventory items, and it will discuss some of the problems that can arise when errors are made in the recording of inventory items.
Chapter Organization