Accounting Study Guide

GAAP

      Inventories are valued at cost or market, whichever is lower. 
      [ARB No. 43, Chapter 4, Para. 8] 

Market Value of Inventories [ARB No. 43, Chapter 4, Para. 9]

 
      Market = Current replacement cost 

      Upper limit of Market
          = Net Realizable Value (NRV)
      Lower limit of Market
          = Net Realizable Value (NRV) - Normal Profit Margin

      Net Realizable Value (NRV)
          = Estimated Selling Price - Cost of Completion and Disposal

      Market = Current Replacement Cost

      If Current Replacement Cost > Net Realizable Value (NRV),
          then NRV is Market.

      If Current Replacement Cost < (NRV - Normal Profit Margin),
          then (NRV - Normal Profit Margin) is Market.

   Company has the following items as inventory as of December 31, 2006.  What is the value of inventory by applying Lower of Cost of Market?
 

Item	Units	Cost	Current Replacement Cost	Estimated Selling Price	Completion & Disposal Cost
1	500	$65	$68	$80	$3
2	300	$80	$72	$102	$8
3	400	$90	$105	$112	$10
4	700	$38	$42	$40	$4
5	900	$20	$21	$30	$2
6	600	$55	$45	$67	$2

   For all inventory items, Normal Profit Margin is 30% of cost.

   Determine the Market
 

Points       Market = Current Replacement Cost       If Current Replacement Cost > Net Realizable Value (NRV),           then NRV is Market.       If Current Replacement Cost < (NRV - Normal Profit Margin),           then (NRV - Normal Profit Margin) is Market.       Rank the following three values, then the one in the middle is Market.           NRV           Current Replacement Cost           NRV - Normal Profit Margin       Net Realizable Value (NRV)           = Estimated Selling Price - Cost of Completion and Disposal       In this example, normal profit margin = 30% of cost.

	(A)	(B)	(C)	Middle value among (A), (B) and (C)
Item	Current Replacement Cost	NRV	Normal - Normal Profit Margin	Market
1	$68	$77	$57.5	$68
2	$72	$94	$70	$72
3	$105	$102	$75	$102
4	$42	$36	$24.6	$36
5	$21	$28	$22	$22
6	$45	$65	$48.5	$48.5

   Compare the Cost and Market
 

Item	Cost	Market	Lower of Cost or Market (LCM)	Units	LCM Inventory
1	$65	$68	$65	500	$32,500
2	$80	$72	$72	300	$21,600
3	$90	$102	$90	400	$36,000
4	$38	$36	$36	700	$25,200
5	$20	$22	$20	900	$18,000
6	$55	$48.5	$48.5	600	$29,100
Total					$162,400

  Inventory valuation at Cost, Market and LCM
 

Item	Units	Inventory at Cost		Inventory at Market		Inventory at LCM
1	500	$32,500	<	$34,000		$32,500
2	300	$24,000	>	$21,600		$21,600
3	400	$36,000	<	$40,800		$36,000
4	700	$26,600	>	$25,200		$25,200
5	900	$18,000	<	$19,800		$18,000
6	600	$33,000	>	$29,100		$29,100
Total		$170,100	<	$170,500		$162,400

   LCM applied to each inventory item
          --> Inventory at LCM = $162,400

   LCM applied to all inventories as one pool
         --> Total inventory at cost < Total inventory at market
         --> Inventory at LCM = $170,100

   Company has the following items as inventory as of December 31, 2006.  What is the value of inventory by applying Lower of Cost of Market?
 

Item	Units	Cost	Current Replacement Cost	Estimated Selling Price	Completion & Disposal Cost
1	800	$220	$250	$280	$15
2	600	$190	$175	$240	$11
3	350	$310	$370	$390	$23
4	500	$180	$185	$185	$8
5	750	$205	$210	$320	$14
6	900	$150	$110	$170	$7

   For all inventory items, Normal Profit Margin is 30% of cost.

   Determine the Market
 

	(A)	(B)	(C)	Middle value among (A), (B) and (C)
Item	Current Replacement Cost	NRV	Normal - Normal Profit Margin	Market
1	$250	$265	$199	$250
2	$175	$229	$172	$175
3	$370	$367	$274	$367
4	$185	$177	$123	$177
5	$210	$306	$244.5	$244.5
6	$110	$163	$118	$118

   Compare the Cost and Market
 

Item	Cost	Market	Lower of Cost or Market (LCM)	Units	LCM Inventory
1	$220	$250	$220	800	$176,000
2	$190	$175	$175	600	$105,000
3	$310	$367	$310	350	$108,500
4	180	$177	$177	500	$88,500
5	$205	$244.5	$205	750	$153,700
6	$150	$118	$118	900	$106,200
Total					$737,950

  Inventory valuation at Cost, Market and LCM
 

Item	Units	Inventory at Cost		Inventory at Market		Inventory at LCM
1	800	$176,000	<	$200,000		$176,000
2	600	$114,000	>	$105,000		$105,000
3	350	$108,500	<	$128,450		$108,500
4	500	$90,000	>	$88,500		$88,500
5	750	$153,750	<	$183,375		$153,700
6	900	$135,000	>	$106,200		$106,200
Total		$777,250	<	$811,525		$737,950

   LCM applied to each inventory item
          --> Inventory at LCM = $737,950

   LCM applied to all inventories as one pool
         --> Total inventory at cost < Total inventory at market
         --> Inventory at LCM = $777,250

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