ch9-lec-1 - CHAPTER 9 Inventories: Additional Valuation...

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CHAPTER 9 Inventories: Additional Valuation Problems 1. Inventories Are Reported at Lower of Cost or Market 1.1 When the future revenue-producing ability associated with inventory is below its original cost, the inventory should be written down to reflect this loss. This is known as the lower of cost or market (LCM) method of valuing inventory. 1.2 Three steps to determine LCM: Step 1 : Determine inventory cost; Step 2: Determine the “market value” of inventory. 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) which is also referred to as the ceiling (the upper limit), nor should it be less than net realizable value less a normal markup which is referred to as the floor (the lower limit). For example, Inventory at sales value $800 Less: Cost to complete and sell 200 Net realizable value (NRV) (the ceiling) 600 Less: Normal markup 100 NRV less normal markup (the floor) $500 Market value is determined by comparing replacement cost of the inventory with the upper and lower limits, and designated market value is always the middle value of replacement cost, the upper limit (the ceiling), and the lower limit (the floor). 9-1
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Step 3: Compare the cost with the designated market value and choose the lower of the two to be reported on the balance sheet. There are three ways to compare the two: (a) Each individual item; (b) Each category; or (c) The total inventory The individual-item approach is preferred by many companies because tax rules require its use when practical, and it produces the most conservative inventory valuation on the balance sheet. When inventory is written down to market, this
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This note was uploaded on 11/30/2011 for the course ACC 101 taught by Professor B during the Spring '09 term at CUNY Baruch.

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ch9-lec-1 - CHAPTER 9 Inventories: Additional Valuation...

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