Reading and Interpreting Gap Inc.'s Inventory Note
Response to the following problem:
The 2006 annual report for Gap Inc. includes the following information in the note that summarizes its accounting policies:
Merchandise Inventory
In fiscal 2005, we implemented a new inventory system and effective January 29, 2006 (the beginning of fiscal 2006), we changed our inventory flow assumption from the first-in, first-out ("FIFO") method to the weighted average cost method ("WAC"). The change in inventory accounting method did not have a material impact on the fiscal 2006 financial statements and, because the effect on prior periods presented is not material, they have not been restated as would be required by SFAS 154.
We review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes) and use markdowns to clear merchandise. We value inventory at the lower of cost or market and record a reserve when future estimated selling price is less than cost. In addition, we estimate and accrue shortage for the period between the last physical count and the balance sheet date. Our shortage estimate can be affected by changes in merchandise mix and changes in actual shortage trends. We estimate and accrue shortage for the period between the last physical count and the balance sheet date. Our shortage estimate can be affected by changes in merchandise mix and changes in actual shortage trends. Required
1. What inventory costing method did Gap Inc. use prior to the 2006 fiscal year?
2. What inventory costing method did Gap Inc. change to beginning with the 2006 fiscal year? Why would a company decide to change its inventory method?
3. Gap Inc. values its inventory at the lower of cost or market. How does the company define market? What factors does it take into account in deciding whether to write down its inventory?