Chapter 9 Class Notes

Chapter 9 Class Notes - Chapter 9 INVENTORIES: ADDITIONAL...

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Chapter 9 INVENTORIES: ADDITIONAL VALUATION ISSUES The Lower-of-Cost-or-Market Concept Inventories are recorded at their cost. However, if inventory declines in value below its original cost, a departure from historical cost occurs. Historical cost is abandoned when the future utility (revenue-producing ability) of the asset drops below its original cost. Therefore, inventories are reported at the lower of cost or market at each reporting period and a loss is charged against revenues in the period in which the loss occurs, not in the period of sale. This complies with the matching principle as well as being a conservative approach to inventory valuation. In summary, a company abandons the historical cost principle when the future utility of the asset drops below its original cost. Recall that ‘cost’ is the acquisition price of inventory computed using one of the historical cost-based cost flow assumptions covered in Chapter 8 – SI, AC, FIFO, and LIFO. The term ‘market’ in the phrase “the lower-of-cost-or-market” (LOCOM) generally means the cost to replace the item by purchase or reproduction, in the market in which the company ‘sells’ the item ! Another way to state this concept is that companies value inventory items at cost or cost to replace, whichever is lower . Replacement Cost & Ceiling and Floor Limitations In the United States, we use ‘ replacement cost ’ to represent market value . Because a decline in the replacement cost of an item usually reflects or predicts a decline in the item’s selling price. Using replacement case allows a company to maintain a consistent rate of gross profit on sales (normal profit margin). Sometimes, however, a reduction in the replacement cost of an item fails to indicate a corresponding reduction in its utility. This requires using two additional valuation limitations to value ending inventory – net realizable value and net realizable value less a normal profit margin . Net realizable value (NRV) is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion and disposal (often referred to as net selling price). The NRV represents the CEILING in the market value calculation. A normal profit margin
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This note was uploaded on 12/09/2011 for the course ACC 371 taught by Professor Proscott during the Spring '11 term at S. Alabama.

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Chapter 9 Class Notes - Chapter 9 INVENTORIES: ADDITIONAL...

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