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To Determine Lower of Cost or Market

To Determine Lower of Cost or Market. First, Determine “Market”:. Identify Replacement Cost of the Item. This is the amount you would pay to replace the item. Identify the Net Realizable Value of the Item.

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To Determine Lower of Cost or Market

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  1. To Determine Lower of Cost or Market First, Determine “Market”: • Identify Replacement Cost of the Item This is the amount you would pay to replace the item • Identify the Net Realizable Value of the Item This is the amount you could reasonably sell the item for in course of business, minus completion and sales costs. • Compute Net Realizable Value minus normal • profit margin This is a floor that is computed to prevent understatement of inventory. “Market” is the middle of these three values.

  2. To Determine Lower of Cost or Market Next, Determine New Inventory Value: Compare “market” to historical cost value Select the lower value of these two This can be done at the individual item level, the inventory category level, or at the total inventory level.

  3. Lower of Cost or Market Example • Paterno Motors has the following in inventory: • 1 Ford Explorer • 1 Toyota Forerunner • 1 Dodge Caravan • 1 4x4 tire • 1 4x4 foglight kit They also have a 20% normal profit margin above historical cost.

  4. Item-by-Item Method Assume these numbers are already known. These must be computed.

  5. Item-by-Item Method First, determine “market” by taking middle value.

  6. Item-by-Item Method Next, choose lower of historical cost or “market.”

  7. Item-by-Item Method Do the same procedures, Item-by-Item.

  8. Item-by-Item Method

  9. Item-by-Item Method

  10. Item-by-Item Method

  11. Item-by-Item Method

  12. Item-by-Item Method

  13. Item-by-Item Method

  14. Item-by-Item Method

  15. Item-by-Item Method

  16. Category Method Total up each column within Category. Then apply the same method.

  17. Category Method

  18. Category Method

  19. Category Method

  20. Category Method

  21. Total Inventory Method Total all columns then apply same method.

  22. Total Inventory Method

  23. Final Total Inventory Value

  24. Presenting the Markdown to Market Assume Paterno chooses Total Inventory Method (LCM yields ending balance of $53,610) Need a journal entry to adjust inventory balance down from Historical Cost balance of $57,130 to LCM ending balance of $53,610 (a difference of $3,520). Two methods of adjustment: • Direct method: Adjust directly to Inventory and directly • to Cost of Goods Sold • Allowance method: Adjust to contra-asset allowance • account and to Holding Loss account

  25. Presenting the Markdown to Market • Direct Method: • Cost of Goods Sold 3,520 • Inventory 3,520 • Allowance Method: • Inventory Holding Loss 3,520 • Inventory LCM Allowance 3,520

  26. Sales Beg Inv. Purchs. CoGAS End Inv. COGS Gross Marg. Stated at LCM Stated at Historical Cost Presenting the Markdown to Market Direct Method Allowance Method 82,000 82,000 95,000 95,000 20,000 20,000 115,000 115,000 (53,610) (57,130) (61,390) (57,870) 20,610 24,130 (3,520) Holding Loss 20,610 Adj. Gross Marg.

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