Textbook Problem

Various Inventory Issues

Hudson Company, which is both a wholesaler and a retailer, purchases its inventories from various suppliers. Additional facts tor Hudson’s wholesale d operations are as follows:

• Hudson incurs substantial warehousing costs.
• Hudson uses the lower of cost or market rule.
• The replacement cost of the inventories is below the net realizable value and above the net realizable value minus the normal profit margin. The original cost of the inventories is above the replacement cost and below the net realizable value.

Additional facts for Hudson’s retail operations are as follows:

• Hudson determines the estimated cost of its ending inventories held for sale at retail using the conventional retail inventory method.
• Hudson incurs substantial freight-in costs.
• Hudson has net additional markups and net markdowns.

Required:

1. Theoretically, how should Hudson account for the warehousing costs related to its wholesale inventories? Why?

2. a. In general, explain why the lower of cost or market rule is used to report inventory.

b. At which amount should Hudson report the wholesale inventories on its balance sheet? Explain the application of the lower of cost or market rule in this situation.

3. In the calculation of the cost-to-retail percentage used to determine the estimated cost of its ending retail inventories, how should Hudson treat:

a. freight-in costs

b. net additional markups

c. net markdowns

4. Explain why Hudson’s retail inventory method approximates lower of average cost or market.