chap09els - Part A: ReportingLower of Cost or Market I....

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Part A: Reporting—Lower of Cost or Market I. Determining Market Value A. Inventories are reported at the lower of cost or market (LCM) . B. The LCM approach to valuing inventory recognizes losses in the period when the value of inventory declines below cost. C. Market value for LCM purposes is the inventory's current replacement cost (RC) except that market should: 1. Not exceed the net realizable value (that is, estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal). 2. Not be less than net realizable value (NRV) reduced by an allowance for an approximately normal profit margin D. NRV provides a ceiling and NRV less a normal profit margin (NRV-NP) a floor between which market must fall. This means that the designated market value is the number that falls in the middle of the three possibilities: RC, NRV, and NRV-NP. E. Replacement cost usually is a good indicator of the direction of change in selling price. The upper and lower limits placed on replacement cost prevent certain types of profit distortion. II. Applying Lower of Cost or Market A. The LCM rule can be applied to individual items, logical inventory categories, or the entire inventory. B. Applying LCM to groups of inventory items usually will cause a higher inventory valuation than if applied item-by-item because group application permits decreases in the market value of some items to be offset by increases in others. C. Each approach is acceptable but should be applied consistently from one period to another. III. Adjusting Cost to Market A. The preferable way to report a loss from an inventory write-down is as a separate item in the income statement. B. A less desirable approach is to include the loss in cost of goods sold. Illustration Part B: Inventory Estimation Techniques I. The Gross Profit Method A. The gross profit method is useful in situations where estimates of inventory are desirable: 1. In determining the cost of inventory that has been lost, stolen, or destroyed. 2. In estimating inventory and cost of goods sold for interim periods. 3. In auditors' testing of the overall reasonableness of inventory amounts reported by clients. 4. In budgeting and forecasting.
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chap09els - Part A: ReportingLower of Cost or Market I....

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