CH 9 Flashcards
When does a company abandon historical costs
a. A company abandons the historical cost principle when the future utility ( revenue-producing ability) of the asset drops below its original cost
When a company abandons historical costs, what occurs with inventory
a. Report inventories at the lower of cost or market
The term market refers to?
a. Cost to replace the item by purchase or reproduction
When should “ departure of cost” could be justified?
a. Company should charge a loss of utility against revenues in the period in which the loss occurs , not period of sale
What is a conservative approach to inventory valuation?
a. Lower of cost or market method
Why use replacement cost to represent market value?
a. A decline in the replacement cost of an item usually reflect or predicts a decline in selling price
b. Replacement cost allows a company to maintain a consistent rate of gross profit on sales
Define Net realizable value
a. Estimated selling price in the ordinary course of business, less reasonably predictable costs of completion and disposal ( often referred to as net selling price)
Define net realizable value less a normal profit margin
a. Normal profit margin is subtracted from normal profit margin
b. The floor ( lower limit)
What is LCM or cost rule
a. A company values inventory at the lower of cot or market with market limited to an amount that is not more than NRV or less than NRV less a normal profit margin
Define upper limit( ceiling)
a. NRV of inventory
b. The highest amount at which inventory can be reported
c. Ceiling prevents overstatement of inventories and understatement of loss in the current period
Define lower limit( floor)
a. LCM rule
b. Lowest amount at which inventory can be reported
c. Computed as the NRV less a normal profit margin. This minimum amount measures what the company can receive for the inventory and still earn a normal profit
What is prevents overstatement of value of obsolete , damaged, or shopworn inventories?
a. A company should not exceed NRV’s ceiling
NRV reduced by an allowance for an approximately normal profit margin is called minimum limitation? True or False
a. True
i. The floor establishes a value below which a company should not price inventory, regardless of replacement cost
Define Designate market value
a. Amount that a company compares to cost
b. It is always the middle value of three amounts
i. In replacement cost,
ii. NRV
iii. NRV less a normal profit margin
What are the two methods used to record the income effect of valuing inventory at market
a. COGS method
b. Loss method
Define COGS method
a. A method of valuing inventory in which COGS is debited for the write down of inventory to market
i. So, company does not report a loss in the income statement because the COGS already includes the amount of loss
Define Loss method
A method of valuing inventory in which a loss account is debited for the write down of the inventory to market, as opposed to the COGS method which buries the loss in the COGS account
Instead of crediting the inventory account for market adjustments, what do companies record which account?
a. Allowance to reduce inventory to market
b. i.e., (DR) Loss Due to Decline of inventory to market
i. (CR) allowance to reduce inventory market
1. This reports both cost and the market value of inventory
What are deficiencies of LCM or cost
a. Company recognizes deceases in the value of the asset and the charge to expense in the period in which the loss in utility occur not in the period of sale
b. Application of the rule results in inconsistency because a company may value the inventory at cost in one year and at market in the next year
c. LCM or cost values the inventory in the balance sheet conservatively, but its effect on the income statement may or may not be conservative
d. Application of the LCM or cost rule uses a “ normal profit in determining inventory values
What should companies define more clearly
a. “ market” as NRV rather than replacement cost
What are limited circumstances that GAAP permits this exception to recording revenue at NRV
a. When there is a controlled market with a quoted price applicable to all quantities
b. When no significant costs of disposal are involved
c. Allowing valuation at NRV is that sometimes it is too difficult to obtain the cost figures
Define purchase commitments
a. Agreements to buy inventory weeks, months, or even years in advance