CHAPTER 9 REVIEW - CHAPTER9REVIEW 1. Chapter 9 concludes...

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CHAPTER 9 REVIEW 1. Chapter 9 concludes the discussion of inventories by addressing certain unique valuation problems not covered in Chapter 8. Chapter 9 also includes a description of the development and use of various estimation techniques used to value ending inventory without a physical count. Lower of Cost or Market 2. (S.O. 1) When the future revenue-producing ability associated with inventory is below its original cost, the inventory should be written down to reflect this loss. Thus, the historical cost principle is abandoned when the future utility of the asset is no longer as great as its original cost. This is known as the lower-of-cost-or-market (LCM) method of valuing inventory and is an accepted accounting practice. When inventory declines in value below its original cost, the inventory should be written down to reflect the loss. This loss of utility in inventory should be charged against revenue in the period in which the loss occurs. 3. The term “market” in lower of cost or market generally refers to the replacement cost of an inventory item. However, market value should not exceed net realizable value (NRV), nor should it be less than net realizable value less a normal markup. These are known as the upper (ceiling) and lower (floor) limits of market, respectively. Market is defined as replacement cost if such cost falls between the upper and lower limits. Should replacement cost be above the upper limit, market would be defined as net realizable value. If replacement cost falls below the lower limit, market is defined as net realizable value less a normal markup. *Note: All asterisked (*) items relate to material contained in the Appendix to the chapter. 4. For example, consider the following illustration. Inventory at sales value $800 Less: Cost to complete and sell 200 Net realizable value (NRV) 600 Less: Normal markup 100 NRV less normal markup $500 To arrive at the final inventory valuation, market value must be determined and then compared to cost. Market value is determined by comparing replacement cost of the inventory with the upper and lower limits. If replacement cost of the inventory in the example is $550, then $550 is compared to cost in determining lower of cost or market because
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replacement cost falls between the upper ($600) and lower ($500) limits. If replacement cost of the inventory is $650, it would exceed the upper limit; thus the upper limit ($600) would be compared to cost in determining lower of cost or market. Similarly, if replacement cost of the inventory is $450, it would be lower than the lower limit and thus the lower limit ($500) would be compared to cost in determining lower of cost or market. The amount that is compared to cost, often referred to as designated market value, is always the middle value of the three amounts: replacement cost, net realizable value, and net realizable value less a normal profit margin. 5.
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This note was uploaded on 09/30/2008 for the course ACCY 206 taught by Professor Madlinger during the Spring '08 term at Northern Illinois University.

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CHAPTER 9 REVIEW - CHAPTER9REVIEW 1. Chapter 9 concludes...

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