Week 4 - Ch 9

Week 4 - Ch 9 - CHAPTER 9 INVENTORIES: INVENTORIES:...

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C H A P T E R C H A P T E R 9 9 INVENTORIES: INVENTORIES: ADDITIONAL VALUATION ISSUES ADDITIONAL VALUATION ISSUES Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield
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Market = Replacement Cost Lower of Cost or Replacement Cost Loss should be recorded when loss occurs, not in the period of sale. Any write-down in inventory cannot be recovered in subsequent year if market value increases A company abandons the historical cost principle when the future utility (revenue-producing ability) of the asset drops below its original cost. Lower-of-Cost-or-Market Lower-of-Cost-or-Market LCM
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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? Lower-of-Cost-or-Market Lower-of-Cost-or-Market Ceiling and Floor
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Not Not < Cost Market Ceiling = NRV Replacement Cost Floor = NRV less Normal Profit Margin GAAP LCM What is the rationale for the Ceiling Ceiling and Floor Floor limitations? Lower-of-Cost-or-Market Lower-of-Cost-or-Market Not Not > Illustration 9-3
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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. Lower-of-Cost-or-Market Lower-of-Cost-or-Market Rationale for Limitations
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Lower-of-Cost-or-Market Lower-of-Cost-or-Market Methods of Applying LCM Illustration 9-6
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Lower-of-Cost-or-Market Lower-of-Cost-or-Market Recording LCM (data from Illus. 9-5 and 9-6) Ending inventory (cost) $ 415,000 Ending inventory (LCM) 350,000 Adjustment to LCM $ 65,000 Allowance on inventory Loss on inventory Inventory Cost of goods sold Allowance Method Direct
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Allowance Direct Current assets: Cash 100, 000 $ Accounts receivable 350, 000 I nventory 770, 000 705, 000 Less: inventory allowance (65, 000) Prepaids 20, 000 Total current assets 1, 175, 000 Lower-of-Cost-or-Market Lower-of-Cost-or-Market Balance Sheet Presentation
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Allowance Direct Sales 300,000 $ 300,000 Cost of goods sold 120,000 185,000 Gross profit 180,000 115,000 Operating expenses: Selling 45,000 45,000 General and administrative 20,000 20,000 Total operating expenses 65,000 65,000 Other revenue and expense: Loss on inventory - I nterest income 5,000 5,000 Total other (60,000) I ncome from operations 55,000 55,000 I ncome tax expense 16,500 16,500 Net income 38,500 38,500 Lower-of-Cost-or-Market Lower-of-Cost-or-Market Income Statement Presentation
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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. 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: Lower-of-Cost-or-Market Lower-of-Cost-or-Market Evaluation of LCM Rule
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Week 4 - Ch 9 - CHAPTER 9 INVENTORIES: INVENTORIES:...

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