FAR - Inventory 4 Flashcards
Lower of Cost or Market (LCM)
What is the Max Ceiling?
What is the Floor?
MARKET
Ceiling = Net Realizable Value = Selling Price minus Cost/Disposal Fees (MAX)
Floor = NRV - Profit Margin
COST
Use Original Cost if below the Floor
Loft Co. reviewed its LIFO basis inventory values for proper pricing at year end. The following summarizes two inventory items examined for the lower of cost or market:
Inventory
Inventory
item #1
item #2
Original cost
$210,000
$400,000
Replacement cost
150,000
370,000
Net realizable value (NRV)
240,000
410,000
Net realizable value (NRV) minus profit margin
208,000
405,000
What amount should Loft include in inventory at year end if it uses the total of the inventory to apply the lower of cost or market (LCM)?
$610,000
Depending on the character and composition of the inventory, the LCM rule may properly be applied either directly to each item or to the aggregate total of the inventory (or, in some cases, to the total of the components of each major category). The method should be the one that most clearly reflects periodic income. LCM by item will always be equal to or less than the other LCM measurements. LCM in total will always be equal to or greater than the other LCM measurements. Under the LCM rule, inventory is measured at the lower of cost or current replacement cost. Market is current replacement cost subject to maximum and minimum amounts. The maximum is NRV ($240,000 + $410,000 = $650,000). The minimum is NRV minus normal profit ($208,000 + $405,000 = $613,000). When replacement cost ($150,000 + $370,000 = $520,000) is less than NRV minus a normal profit, the minimum is used in the comparison with cost. Given that original cost is below this minimum, the measure of the inventory item is the $610,000 total cost ($210,000 + $400,000).
Subsequent events include which of the following?
- Events or transactions that provide evidence about conditions at the date of the balance sheet, including the estimates inherent in statement preparation.
- Events or transactions that provide evidence about conditions that did not exist at the date of the balance sheet.
Both
Subsequent events are events or transactions that occur after the balance sheet date and prior to the issuance (or availability for issuance) of the financial statements. Certain subsequent events or transactions provide evidence about conditions at the date of the balance sheet, including the estimates inherent in statement preparation. Other subsequent events or transactions provide evidence about conditions that did not exist at the date of the balance sheet.
On December 28, Kerr Manufacturing Co. purchased goods costing $50,000. The terms were FOB destination. Some of the costs incurred in connection with the sale and delivery of the goods were as follows:
Packaging for shipment
$1,000
Shipping
1,500
Special handling charges
2,000
These goods were received on December 31. In Kerr’s December 31 balance sheet, what amount of cost for these goods should be included in inventory?
$50,000
FOB destination means that title passes upon delivery at the destination, the seller bears the risk of loss during transit, and the seller is responsible for the expense of delivering the goods to the designated point. Consequently, the packaging, shipping, and handling costs are not included in the buyer’s inventory. The amount that Kerr should include is therefore the purchase price of $50,000.
During Year 4, R Corp., a manufacturer of chocolate candies, contracted to purchase 100,000 pounds of cocoa beans at $1.00 per pound, with delivery to be made in the spring of Year 5. Because a record harvest is predicted for Year 5, the price per pound for cocoa beans had fallen to $.80 by December 31, Year 4. Of the following journal entries, the one that would properly reflect in Year 4 the effect of the commitment of R Corp. to purchase the 100,000 pounds of cocoa is
Loss on purchase commitments
$20,000 (DR)
Accrued loss on purchase commitments
$20,000 (CR)
This answer is correct.
Recognition of the loss in the income statement and accrual of a liability in Year 4 are required (assuming the purchase commitment is noncancelable). The loss on purchase commitments is an expense. Accrued loss on purchase commitments is a liability.
On December 1, Alt Department Store received 505 sweaters on consignment from Todd. Todd’s cost for the sweaters was $80 each, and they were priced to sell at $100. Alt’s commission on consigned goods is 10%. At December 31, 5 sweaters remained. In its December 31 balance sheet, what amount should Alt report as payable for consigned goods?
$45,000
Consignment-in is a receivable/payable account used by consignees. It is the amount payable to the consignor if it has a credit balance. The amount of the payable equals total sales minus 10% commission on the goods sold, or $45,000 [(500 × $100) sales – (500 × $100 × 10%)].
Net losses on firm purchase commitments to acquire goods for inventory result from a contract price that exceeds the current market price. If a firm expects that losses will occur when the purchase occurs, expected losses, if material,
Should be recognized in the accounts and separately disclosed as losses on the income statement of the period during which the decline in price takes place.
This answer is correct.
A loss is accrued in the income statement on goods subject to a firm purchase commitment if the market price of these goods declines below the commitment price. This loss should be measured in the same manner as inventory losses. Disclosure of the loss is also required.
An entity that prepares its financial statements using IFRS reported the following selected per-unit data relating to work-in-process:
Selling price
$100
Completion costs
10
Historical cost
91
Replacement cost
108
Normal gross profit
20
Selling cost
5
In comparison with historical cost, what will be the per-unit effect on gross profit of measuring ending inventory?
Reduction of $6
Under IFRS, inventories are measured subsequent to acquisition at the lower of cost or net realizable value (NRV). NRV equals selling price minus estimated completion and selling costs. Given that historical cost is $91 and NRV is $85 ($100 selling price – $10 completion cost – $5 selling cost), the effect on per-unit gross profit is a reduction of $6. This amount is expensed and presented as a component of cost of goods sold.
The original cost of an inventory item is above the replacement cost. The inventory item’s replacement cost is above the net realizable value. Under the lower-of-cost-or-market method, the inventory item accounted for using the retail inventory method should be valued at
NRV
Inventory accounted for using LIFO or the retail inventory method is measured at the lower of cost or market. Market is the current cost to replace inventory, subject to certain limitations. Market should not exceed a ceiling equal to net realizable value (NRV) or be less than a floor equal to NRV minus a normal profit margin. Because replacement cost exceeds NRV, the ceiling is NRV.
On March 15, Year 4, Krol Company paid property taxes of $180,000 on its factory building for the Year 4 calendar year. On April 1, Year 4, Krol made $300,000 in unanticipated repairs to its plant equipment. The repairs will benefit operations for the remainder of the calendar year. What total amount of these expenses should be included in Krol’s quarterly income statement for the 3 months ended June 30, Year 4?
$145,000
The benefit from the payment of the property taxes relates to all four quarters of Year 4 and should be prorated at $45,000 ($180,000 ÷ 4) per quarter. The benefit from the unanticipated repairs to plant equipment relates to the second, third, and fourth quarters. It should be spread evenly over these quarters at $100,000 ($300,000 ÷ 3) per quarter. The total amount of expenses that should be included in the quarterly income statement for the 3 months ended June 30, Year 4, is therefore $145,000.
Lorraine Co. has determined its fiscal year-end inventory on a LIFO basis to be $400,000. Information pertaining to that inventory follows:
Estimated selling price
$408,000
Estimated cost of disposal
20,000
Normal profit margin
60,000
Current replacement cost
360,000
Lorraine records losses that result from applying the lower-of-cost-or-market (LCM) rule. At its year end, what should be the net carrying value of Lorraine’s inventory?
$360,000
Inventory accounted for using LIFO or the retail inventory method is measured at the lower of cost or market. Under the LCM method, market is current replacement cost subject to a maximum (ceiling) equal to net realizable value and a minimum (floor) equal to net realizable value minus a normal profit. NRV equals selling price minus costs of completion and disposal. Here, original cost is $400,000 and replacement cost is $360,000. The LCM method uses the lower of the two, $360,000, to measure inventory. However, the inventory measure cannot exceed the NRV of $388,000 ($408,000 selling price – $20,000 cost of disposal). Furthermore, the inventory carrying amount cannot be lower than NRV minus normal profit, or $328,000 ($388,000 NRV – $60,000 normal profit). Because the lower of cost or market ($360,000) is between $388,000 (ceiling) and $328,000 (floor), the net carrying amount is $360,000.
On November 1, Year 1, Iba Co. entered into a contract with a customer to sell 150 machines for $75 each. The customer obtains control of the machines at contract inception. Iba’s cost of each machine is $45. Iba allows the customer to return any unused machine within 1 year from the sale date and receive a full refund. Iba uses the expected value method to estimate the variable consideration. Based on Iba’s experience and other relevant factors, it reasonably estimates that a total of 20 machines (12 machines in Year 1 and 8 machines in Year 2) will be returned. Iba estimates that (1) the machines are expected to be returned in salable condition and (2) the costs of recovering the machines will be immaterial. During Year 1, 10 machines were returned. At the end of Year 1, Iba continues to estimate that a total of 20 machines will be returned within 1 year from the sale date.
What amount of revenue from this contract will be recognized by Iba in Year 1?
$9,750
Given a right of return, the consideration received from the customer is variable. Revenue from variable consideration is recognized only to the extent that it is probable that a significant reversal will not occur. Iba estimates that 20 machines will be returned. Thus, in Year 1 Iba recognizes revenue only for the sale of 130 machines (150 – 20), and the revenue recognized is $9,750 (130 × $75).
Which of the following is a component of other comprehensive income?
Cumulative currency-translation adjustments
Foreign currency translation adjustments for a foreign operation that is relatively self-contained and integrated within its environment do not affect cash flows of the reporting entity. They should be excluded from earnings. Accordingly, translation adjustments are reported in other comprehensive income (OCI).
On December 1, Year 4, Tigg Mortgage Co. gave Pod Corp. a $200,000, 12% loan. Pod received proceeds of $194,000 after the deduction of a $6,000 nonrefundable loan origination fee. Principal and interest are due in 60 monthly installments of $4,450, beginning January 1, Year 5. The repayments yield an effective interest rate of 12% at a present value of $200,000 and 13.4% at a present value of $194,000. What amount of accrued interest receivable should Tigg include in its December 31, Year 4, balance sheet?
$2,000
Accrued interest receivable is always equal to the face amount times the nominal rate for the period of the accrual. Thus, the accrued interest receivable is $2,000 [$200,000 × 12% × (1 ÷ 12)].
A company determined the following values for its inventory as of the end of the fiscal year:
Historical cost
$100,000
Current replacement cost
70,000
Net realizable value
90,000
Net realizable value minus a normal
profit margin
85,000
Fair value
95,000
Under IFRS, what amount should the company report as inventory on its balance sheet?
$90,000
Under IFRS, inventory is measured at the lower of cost or NRV (estimated selling price in the ordinary course of business – estimated costs of completion and sale). Given cost of $100,000 and NRV of $90,000, inventory should be reported at $90,000.
