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Case #5 Inventory Valuation




Question;We started the course;looking at the accounting for basic things like bad debts and operating;expenses, and that is how we?ll end it. The subject for our last case is;inventory valuation.;As you read the case, it;will become apparent that there is an added dimension here. We are dealing with;a specific and somewhat unique product---classic French red wines?that actually;improves with age. Also, there is some real history connected with this;case in that the scenario is drawn, for the most part, from something that;actually happened.;You are to write a;letter to Romano Wine Company that outlines the scenario, identifies the;accounting issue, and proposes a solution. Specifically, you must address;how the Bordeaux red wines will be valued on the May 31, 2004 balance sheet and;how that this will impact both the 2004 and 2005 income statements.;Note: You read the;balance sheet date correctly--it is May of 2004. The dates and periods of time;are very important in this case. Therefore, assume that you are looking;into this issue on or about June 15, 2004.;Case #5;Inventory Valuation;The Scenario;The setting for our last;case is the wine industry, and the issue is inventory valuation. Before we go;into specifics, I am going to ask you to assume that wholesale and retail;prices for expensive French red wines (for example, those from Bordeaux) have;declined significantly over the past four months. This is purely an assumption;for purposes of this case. In reality, I doubt that there has been any such;decline.;The Case;The Romano Wine Company;is a relatively small, family owned San Francisco company that distributes wine;to restaurants, general purpose liquor stores, and retail wine shops including;many small boutique shops. Even though Romano is a Sicilian name, the company;is known for its expertise with French wines, particularly the more expensive;reds. Romano has been around since the early sixties and has survived as an;independent distributor mainly because of personal relationships established;and nurtured over forty years.;One of these close;long-lasting relationships is with Wells Fargo Bank ("Wells"), who;provides short-term financing for the company?s inventory and long-term;financing for the company?s warehouse and offices. Wells has always wanted to;see unaudited quarterly financial statements and audited annual financial;statements all prepared according to US GAAP. Romano?s most recent year-end is;May 31, 2004 and the following scenario played-out in early June as part of the;annual audit.;Romano began to see soft;prices for French reds late in 2003, which continued into the current year. In;fact, wholesale prices (and soon after, the retail prices) really started to;drop in early spring of this year. As of June 1, prices are down 30-40% from what;they were in the fall of 2003 and the auditors have raised an issue about the;valuation.;Romano values its;inventory using a weighted average cost basis and utilized the periodic;inventory system. About a third of Romano?s inventory at May 31, 2004 consisted;of red wines from Bordeaux, these 2,100 cases of red wine were purchased at an;average cost of $120 per case, and in normal times would sell for roughly $220;a case. The replacement cost of this inventory at May 31st, was $80;a case, and the current selling price is $146 per case.;How should the Bordeaux;reds be valued on the May 31st balance sheet and what is the impact, if any, on;the 2004 income statement? What will be the impact on the 2005 income;statement?;A proper response should be done within 2 pages or less.;Additional Information;1) This is not the first;time that wine prices have fallen (or risen) dramatically. (After all, grapes;are a commodity even in the Bordeaux area of France!). Romano?s general manager;is kind of a wine historian and he says volatility like this happens at least;twice each decade, and prices always bounce back.;According to your;research the main reason for the price drop is excess produce, especially the;1999-2001 vintages. As soon as the distribution channel is cleared (in other;words as soon as the wine drinkers of the world start drinking this stuff);prices will return to normal. In fact, Romano thinks that prices have;bottomed-out and will start to go back up by the end of the year, and may be;very close to their 2003 levels by late spring 2005.;2) As we all know, if;stored properly a good red wine will improve in the bottle.;Obsolescence/spoilage is not a factor.;3) Romano likes to turn;over its inventory about four times a year. Actually, they don?t have a choice;because they don?t have a lot of excess cash. They must keep their business;cycle at a reasonable length. However, this whole industry, from growers to;distributors to retailers, is characterized by ?slow payers?. Romano, itself;seldom pays less than then 90 days after delivery! On the other hand;businesses eventually pay. A time-honored, unwritten code of conduct is very;much evident in this industry.;4) Romano?s sales for;the year ended 5/31/04 were $2.1 million, and net income was 120,000. Sales;net income, and cash flow from operations were all less than what they were for;year ending 5/31/03.;The following is the;company?s balance sheet as of 5/31/04.;Romano Wine Company;Balance Sheet;May 31, 2004;Cash 85,000 A/P 450,000;A/R (NRV) 500,000 S/T;Debt 500,000;Inventory 750,000 L/T;Debt 875,000;PPE (NBV)950,000;Equity460,000;Total2,285,000Total2,285,000;5) Assume the current;FASB Codification text is the accounting guidance in place during case;timeframe.


Paper#38893 | Written in 18-Jul-2015

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