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Lecture 6

ACCT 3001 Lecture Notes - Lecture 6: Price Ceiling, Profit Margin, Conservation Movement


Department
Accounting
Course Code
ACCT 3001
Professor
lydialafleur
Lecture
6

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CHAPTER 9 INVENTORIES: PART II
1
Note: Retail Inventory Method (pages 458-464) is omitted.
Lower of Cost or Net Realizable Value (LCNRV)
- Inventory is recorded at cost (GAAP)
- May decline in value below its original cost (becomes obsolete)
o Write down inventory to NRV (report the loss)
- Departure from cost principle
- Example of conservationism
Methods of Applying:
- Item-by-item: items individually
o Preferred by many companies
o Tax rules required when practical
o Results in most conservative inventory valuation
- Each category
- Total inventory
Methods of recording:
A company abandons the historical cost principle when the future utility (revenue-producing
ability) of the asset drops below its original cost
Cost: acquisition price computed using historical cost-based methods (Spec id, average cost,
FIFO, LIFO)
Net Realizable Value: net amount company expects to realize (receive) from the sale (estimated
selling price less costs of completion, disposal, and transportation)
BE9-2 Floyd Corporation has the following four items in its ending inventory.
Item
Cost
Net Realizable Value
(NRV)
LCNRV (a)
Jokers
$2,000
$2,100
2,000
Penguins
5,000
4,950
4,950
Riddlers
4,400
4,625
4,400
Scarecrows
3,200
3,830
3,200
Total
14,600
15,505
14,500
Write-down
Item by item: (total LCNRV total cost)
14600-14550 = $50
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CHAPTER 9 INVENTORIES: PART II
2
Total category: (NVR LCNrV)
15505 14,600 = no write down because cost is lower
Recording NRV Instead of Cost: GAAP does not specify
2 Methods- Cost of Goods Sold Method and Loss Method (for debit). Companies usually use an
allowance account instead of directly crediting inventory.
Cost of Goods Sold Method:
COGS XX
Allowance to reduce Inv. to NRV XX
Loss Method:
Loss due to decline in Inv. XX i other epeses o ioe stateet
Allowance to reduce Inv. to NRV XX
The allowance account is typically left on the books and adjusted to agree each year with the
difference between cost and LCNRV at each balance sheet date.
EX: NRV is $2500 less than cost of inventory, allowance account has a $1000 credit balance
2,500 1,000
COGS (or loss) 1,500
Allowance 1,500
Lower of Cost or Market (LCM)
Companies that use LIFO or Retail Inventory Method may use LCM instead of LCNRV
Uses Replacement Cost then applies two limitations- a ceiling and a floor (they pick the number
in the middle)
Ceiling and Floor
Ceiling: net realizable value (defined as estimated selling price of inventory less normal
selling costs, (completion costs and disposal costs)
1. NRV = selling price disposal costs
Floor: net realizable value less a normal profit margin
1. Ceiling normal profit margin
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CHAPTER 9 INVENTORIES: PART II
3
Computation:
1. Calculate market price
Ceiling
Floor
Compare ceiling, floor, and replacement costs
Choose the middle value
2. Compare costs to designated market value
Select the lower of the two
EX: laptop store model cost: $475, replacement cost: 425, original selling price: $600 current
selling price: $400
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
Ceiling = NRV
Replacement
Cost
Floor = NRV
less Normal
Profit Margin
N
ot
<
Cost
Market
LCM
475
400
400
400
425
400-125
= 275
Choose the lowest
between
cost/market
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