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ch09student - 1 Chapter 9 Class Notes 2 Decline in the RC...

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Unformatted text preview: 1 Chapter 9 Class Notes 2 Decline in the RC usually = decline in selling price. RC allows a consistent rate of gross profit. If reduction in RC fails to indicate reduction in utility, then two additional valuation limitations are used: Ceiling- net realizable value and Floor- net realizable value less a normal profit margin. Why use Replacement Cost (RC) for Market? Ceiling and Floor Ceiling – prevents overstatement of the value of obsolete, damaged, or shopworn inventories. Floor – deters understatement of inventory and overstatement of the loss in the current period. 3 Ex: Based on Individual Items (pg 425): NRV - Designated Final Repl NRV Norm π Market Inventory Food Cost Cost (Ceiling) (Floor) Value Value Spinach $ 80,000 $ 88,000 $120,000 $104,000 Carrots 100,000 90,000 100,000 70,000 Cut Beans 50,000 45,000 40,000 27,500 Peas 90,000 36,000 72,000 48,000 Mixed Veg 95,000 105,000 92,000 80,000 Alternative Methods of Applying LCM (pg 425) Lower of Cost or Market Designated Individual Major Total Cost Market Items Categories Inventory Frozen Spinach $ 80,000 Carrots 100,000 Cut Beans 50,000 Tot frozen 230,000 Canned Peas 90,000 Mixed Veg 95,000 Tot canned 185,000 Total $415,000 4 (Try doing this on your own) 5 Expense recorded when loss in utility occurs. Profit on sale recognized at the point of sale. Inventory valued at cost in one year and at market in the next year (not consistent). Net income in year of loss is lower. Net income in subsequent period may be higher than normal if expected reductions in sales price do not materialize. LCM uses a “normal profit” in determining inventory values, which is a subjective measure. Some Deficiencies: Evaluation of LCM Rule 6 7 Generally seller retains title to the merchandise. Buyer recognizes no asset or liability. If material, the buyer should disclose contract details in footnote. If the contract price is greater than the market price, and the buyer expects that losses will occur when the purchase is effected, the buyer should recognize losses in the period during which such declines in market prices take place. Purchase Commitments Example: Assume Taurus Paper Co. signed timber cutting contracts at a price of $2,000,000 to be executed in 2009. The market price of timber cutting rights as of 12/31/2008 dropped to $1,400,000. On December 31, 2008 Taurus would make the following entry: Unrealized holding gain or loss $ 600,000 (“other gains and losses”) Est liability on purchase commitments $600,000 (“current liability”) At the time of harvesting the timber Taurus would make the following JE: Inventory $ 1,400,000 Est liability on purchase commitments 600,000 Cash $2,000,000 If a portion of the loss reverses by say $100,000 we have: Est liability on purchase commitments $100,000 Unrealized holding gain or loss $100,000 8 The Gross Profit Method of Estimating Inventory: Estimates for interim reporting and calculating insurance losses. Uses historical Gross Profit %Estimates for interim reporting and calculating insurance losses....
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This note was uploaded on 09/06/2009 for the course BUS 311 taught by Professor Staff during the Spring '08 term at IUPUI.

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ch09student - 1 Chapter 9 Class Notes 2 Decline in the RC...

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