acct 3001 ch 9 - CHAPTER9INVENTORIES:PARTII 1 2 3 4...

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CHAPTER 9 – INVENTORIES: PART II 1. Lower of Cost or Market 2. Valuation Bases 3. Gross Profit Method 4. Presentation and Analysis 1. Lower of Cost or Market (LCM) A company abandons the historical cost principle when the future utility (revenue- producing ability) of the asset drops below its original cost. Market = Replacement Cost Lower of Cost or Replacement Cost Loss should be recorded when loss occurs, not in the period of sale.  (Conservatism) – given a choice between two accounting methods, choose the  one that understates assets (and earnings) and overstates liabilities (and losses). Ceiling and Floor Why use Replacement Cost (RC) for Market? 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 (defined as estimated selling price of  inventory less normal selling costs, (completion costs and disposal costs)  and Floor - net realizable value less a normal profit margin.
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CHAPTER 9 – INVENTORIES: PART II What is the rationale for Ceiling and Floor limitations? Rationale for Limits: 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.
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CHAPTER 9 – INVENTORIES: PART II
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CHAPTER 9 – INVENTORIES: PART II Class Example – Lower of Cost or Market Brown Company carries four items in inventory.  The following data is available about the items in inventory  as of December 31, 2004.  Determine the proper inventory value using the lower-of-cost-or-market method on (a)  an item-by-item basis and (b) a total inventory basis.  In each instance, make any necessary journal entries. Item Number Of Units Historica l Cost Replacemen t Cost Estimated Selling Price Estimated Selling Costs Profit Margin (as a % of sales) T-shirts 150 $15 $16 $20 $3 15% Shorts 200 9 5 10 2 10% Socks 100 18 21 30 4 20% Pants 125 30 28 40 5 25%
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CHAPTER 9 – INVENTORIES: PART II Balance Sheet Presentation Allowance Direct Current Assets: Cash $100,000 $100,000 Accounts Receivable 350,000 350,000 Inventory 770,000 705,000 Less: inventory Allowance (65,000) Prepaid expense 20,000 20,000 Total current assets $1,175,000 $1,175,000 Income Statement Presentation 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 expenses: Loss on inventory 65,000 Interest income 5,000 5,000
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acct 3001 ch 9 - CHAPTER9INVENTORIES:PARTII 1 2 3 4...

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