Chapter 10, Problem 3JC

Judgment Case 3: Lower of Cost or Market

KR Automotives is a calendar-year car dealer that sells cars made by Hoyta. KR uses LIFO and calculates the lower of cost or market using an individual-item basis. The CFO of KR believes that KR will need to write-down its inventory of one particular car.

The Kaminator has historically sold very well at KR. In fact, in recent years, it has sold above its sticker price of $34,000 because of the high demand for the car. The average selling price of the Kaminator in 2014 was $35,000 and the average selling price in 2015 was $36,000. However, in late 2016, a rival car manufacturer produced a car, the Crumbder, that is very similar to the Kaminator. However, the competitor’s car received significantly higher ratings from consumer organizations that rate cars for safety and gas mileage among other things. In addition, the Crumbder was rated as a “recommended best buy.” Crumbder’s entry on the market significantly reduced sales of the Kaminator; sales in December 2016, after the release of the Crumbder, averaged $27,000. The sales force at KR Automotives is convinced that the sales will stagnate even more in 2017.

The CEO of KR is trying to determine what to do with the 200 Kaminators that were left on the lot on December 31, 2016. He has come up with four possibilities

1. 1. Keep the cars on the lot and try to sell them to retail customers The sales force is very uncertain what price at which they could ultimately sell these cars In a similar situation 10 years ago, KR sold the older cars for 25% below sticker.
2. 2. Sell the cars to dealers overseas. One overseas dealer has already offered to buy 20 Kaminators for $19,000 each. This dealer indicated that it may be willing to buy more, depending upon how well the 20 sell.
3. 3. Sell the cars to a used car lot at a much reduced price, likely around 40% below sticker.
4. 4. Put the cars up for auction KR has not tried this before and has no history of how the cars might sell. There is some limited evidence that indicates that excited buyers might buy the car for sticker price.

The current selling costs are $500 per car and KR uses a 15% profit margin in its LCM computations. KR paid $23,000 per car for the Kaminators that are on the lot. The replacement cost of these cars is $20,000 per car.

What is the most appropriate write-down amount, if any, for the Kaminators? Outline your thought process as well as the judgment(s) you made in reaching this conclusion.