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Unformatted text preview: oods. In other words, what would it cost
for the company to acquire or reproduce the inventory? Download free ebooks at bookboon.com
39 Lower of Cost or Market Adjustments Current Assets: Part II However, the lower-of-cost-or-market rule can become slightly more complex because the
accounting rules further specify that market not exceed a ceiling amount known as “net realizable
value” (NRV = selling price minus completion and disposal costs). The reason is this: occasionally
“replacement cost” for an inventory item could be very high (e.g., a supply of slide rules at an office
supply store) even though there is virtually no market for the item and it is unlikely to produce much
net value when it is sold. Therefore, “market” for purposes of the lower of cost or market test should
not exceed the net realizable value. Additionally, the rules stipulate that “market” should not be less
than a floor amount, which is the net realizable value less a normal profit margin.
What we have then, is the following decision process:
Step 1: Determine Market -- replacement cost, not to exceed the ceiling nor be less than the
Step 2: Report inventory at the lower of its cost or market (as determined in step 1).
To illustrate, consider the following four different inventory items, and note that the “cost” is
shaded in light yellow and the appropriate “market value” is shaded in tan (step 1). The reported
value is in the final row, and corresponds to the lower of cost or market:
Item A Item B Item C Item D $1,000 $2,500 $3,000 $4,000 Replacement cost $1,200 $2,400 $3,000 $2,000 Net realizable value (ceiling) $1,400 $2,800 $2,800 $3,000 NRV less normal profit margin (floor) $1,100 $2,200 $2,200 $2,500 VALUE TO REPORT $1,000 $2,400 $2,800 $2,500 Cost **** Vs. “Market”: 8.2 Application of the Lower-of-Cost-or-Market Rule
Despite the apparent focus on detail, it is noteworthy that the lower of cost or market adjustments
can be made for each item in inventory, or for the aggregate of all the inventory. In the latter case,
the good offsets the bad, and a write-down is only needed if the overall market is less than the
overall cost. In any event, once a write-down is deemed necessary, the loss should be recognized in
income and inventory should be reduced. Once reduced, the Inventory account becomes the new
basis for valuation and reporting purposes going forward. Write-ups of previous write-downs (e.g.,
if slide rules were to once again become hot selling items and experience a recovery in value) would
not be permitted under GAAP. Download free ebooks at bookboon.com
40 Inventory Estimation Techniques Current Assets: Part II 9. Inventory Estimation Techniques
Whether a company uses a periodic or perpetual inventory system, a physical count of goods on
hand should occur from time to time. The quantities determined via the physical count are presumed
to be correct, and any differences between the physical count and amounts reflected in the
accounting records should be matched with an adjustment to the accounting records. Sometimes,
however, a physical count may not be possible or is no...
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This note was uploaded on 06/07/2013 for the course BA 201 taught by Professor Cuongvu during the Fall '13 term at RMIT Vietnam.
- Fall '13