Np margin given in percentage terms, how to determine NP in dollar terms through SP?

CFA Level II
#1

This is for NRV calculation in Inventory under US GAAP. If NP margin isn’t given directly in dollar terms.

Can some one help me with the reasoning in this. I seemed to have forgotten this. Thanks

#2

Are there questions that would require you to calculate the writedown? That seems out of scope for the CFA Exam.

The purpose of the “market” floor in GAAP is to prevent writedowns so deep that they result in an excessive income pick-up in the period when the inventory is finally sold.

If i was given a problem with the Net Profit percentage, I would assume it was intended to be applied to the carrying value of the inventory.

#3

Yes, there are questions based in the Elan guide and EOC where write down calculation were needed.

I get the appliction of US GAAP

Here, I am looking for how to convert NP margin to NP. It says in the guide to apply it to SP to get it in dollar terms. Could u explain this if u have understood the logic behind it?

Thanks.

#4

Net profit margin is defined as:

Net Profit Margin = Net Income / Net Sales

So,

Net Income = Net Sales × Net Profit Margin

#5

oh darn, got confused for a second with net income and net profit lol. Different terminology makes things seem confusing.

Thanks a lot for the explaination.

#6

My pleasure.

#7

If it says in the guide to apply the % to Sales, then you have your answer. I cannot speak to the logic without knowing how they came up with the percentage. In practice, this would be an important detail and I would expect companies with inventory to have a formal policy around this calculation. But since it is a given in your question, I say just go with it. And remember, the idea here is to not write down the inventory so much that when you do sell it you get an abnormal profit.

Sidenote: As for calcualting this “normal profit margin”, I do not think it would be just NI/Sales. Imagine if Best Buy or Amazon or Ford had to write down the value of their inventory for a specific product, They wouldn’t want to use some figure that included all products. Different products have different margins, etc…

#8

Okay, too much coffee earlier, Here is the logic:

Company sells female boxing gloves for $100. Their “normal profit margin” is 25%, or $25. This gives the floor on how low they can write their inventory down. It cannot go below $75, even if they could replace current inventory for $40. Why not? I beleive that the thinking is that the writediwn shouldn’t result in a big fat profit later on the down the line.

That’s how I see it.