pptchapter9

pptchapter9 - Lower of Cost or Market (LCM) Inventories:...

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Slide 9-1 UCSB, Anderson Inventories: Additional Valuation Issues Chapter 9 Slide 9-2 UCSB, Anderson Lower of Cost or Market (LCM) REMEMBER CONSERVATISM! The general rule is that - The historical cost principle is abandoned when the future utility (revenue- producing ability) of the asset is no longer as great as its original cost. Note “abandoned” is not the word I would choose. Good rule of thumb is that historical cost should be adjusted for impairments. New Term: Net Realizable Value (NRV)= normal selling price less costs to sell HOW IT WORKS- Inventory is recorded at the LOWER of cost or market where: – Cost (easy, what you have on the balance sheet if you don’t do anything) – Market= replacement cost, but can not be: » Greater than NRV (ceiling) » Less than NRV minus normal profit margin (floor) Market Value Stated another way: market value is the middle value of replacement cost, NRV and NRV less normal profit margin. Slide 9-3 UCSB, Anderson Cost Market Ceiling = NRV Replacement Cost Floor = NRV less Normal Profit Margin LCM = Not > Not < What is the rationale for these two limitations? Market Slide 9-4 UCSB, Anderson Lower of Cost or Market Example Grant Wood Company manufactures desks. Most of the company’s desks are standard models and are sold on the basis of catalog prices. At December 31, 2002, the following finished desks appear in the company’s inventory: Finished Desks A D C B 2002 catalog selling price $450 $1,050 $900 $480 FIFO cost per inventory (12/31/02) 470 960 830 450 Est. cost to manufacture (12/31/02) 460 1,000 610 440 Sale commissions and disposal costs 45 130 90 60 2003 catalog selling price 500 1,200 900 540 The 2002 catalog was in effect through November 2002, and the 2003 catalog is effective as of December 1, 2002. All catalog prices are net of the usual discounts. Generally, the company attempts to obtain a 20% gross margin on selling price and has usually been successful in doing so.
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Slide 9-5 UCSB, Anderson Previous Slide Computation Finished Desks A B C D 2002 Catalog sel ing price 450 480 900 1,050 FIFO cost per inventory (12/31/02) 470 450 830 960 Est Cost to Manufacture (12/31/02) 460 440 610 1,000 Sales commissions and disposal costs 45 60 90 130 2003 catalog sel ing price 500 540 900 1,200 Replacement cost 460 440 610 1,000 NRV Estimated sales price 500 540 900 1,200 Less: Costs to sel (45) (60) (90) (130) 455 480 810 1,070 Less: Normal profit margin f 20% (100) (108) (180) (240) NRV less normal profit margin 355 372 630 830 Middle Value= designated mkt value 455 440 630 1,000 Cost 470 450 830 960 LCM= Ending inventory 455 440 630 960 Inventory adjustment necessary (15) (10) (200) - Slide 9-6 UCSB, Anderson Don’t be tricked! Gross profit percentage is NOT the same as mark-up percentage.
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This note was uploaded on 08/06/2008 for the course ECON 136A taught by Professor Anderson during the Winter '08 term at UCSB.

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pptchapter9 - Lower of Cost or Market (LCM) Inventories:...

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