Chapter 9 331

Chapter 9 331 - Lecture Notes for Chapter 9(ACCT 331...

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Lecture Notes for Chapter 9 (ACCT 331) Inventories: Additional Issues A. Lower of Cost or Market (LCM) Approach (ARB 43) υ Inventories are initially recorded at historical cost. υ Subsequently if it is determined that the probable future economic benefits from the asset is less than its cost, its value should be adjusted. υ Under the LCM Approach, the existing book value of inventory should be compared to its market value. υ If the market value is lower, inventory value should be reduced to the market value and losses should be recorded. υ There are three possible choices for market value: υ Replacement cost (price to be paid to replace the inventory). υ Net Realizable value (amount that could be obtained from selling the inventory: selling price less disposal costs). υ Net realizable value less normal profit margin. υ From the three market value choices, select the middle value. Why? υ Compare market value with historical cost (book value) of inventory. If market value is lower, reduce the value of inventory. υ LCM adjustment can be done separately for different types of inventory or on the aggregate. Example 9.1 ITEM RC NRV NP NRV-NP HC Market P LCM Take down A 50 55 7 60 B 61 60 10 55 C 72 75 1 65 Lower of Cost or Market (LCM) Method (Continued) 1
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υ The LCM rule can be applied to individual items, logical inventory categories, or the entire inventory. υ For income tax purposes, LCM should be applied on an individual item basis only. υ Example Example 9.2 Lower of cost or market Item Cost Designated Market Value By Individual Items By Product Line By Total Inventory A $ 50,000 $ 65,000 B 100,000 90,000 Total A + B $150,000 $155,000 C $ 80,000 $ 65,000 D 90,000 56,000 E 95,000 86,000 $265,000 $207,000 Total $415,000 $362,000 Recording the LCM Adjustment υ Direct method: The adjustment is reflected directly in the COGS and ending inventory. υ Indirect method : Inventory is reduced through a separate allowance account and income is reduced through a loss account. Example 9.3:
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Chapter 9 331 - Lecture Notes for Chapter 9(ACCT 331...

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