Evaluating the Income Statement and Income Tax Effects of Lower of Cost or Market
Smart Company prepared its annual financial statements dated December 31. The company used the FIFO inventory costing method, but it failed to apply LCM to the ending inventory. The preliminary income statement follows:
Sales Revenue | $280,000 | |
Cost of Goods Sold | ||
Beginning Inventory | $30,000 | |
Purchases | 182,000 | |
Goods Available for Sale | 212,000 | |
Ending Inventory (FIFO cost) | 44,000 | |
Cost of Goods Sold | 168,000 | |
Gross Profit | 112,000 | |
Operating Expenses | 61,000 | |
Income from Operations | 51,000 | |
Income Tax Expense (30%) | 15,300 | |
Net Income | $35,700 |
Assume that you have been asked to restate the financial statements to incorporate LCM. You have developed the following data relating to the ending inventory:
TIP: Inventory write-downs do not affect the cost of goods available for sale. Instead, the effect of the write-down is to reduce ending inventory, which increases Cost of Goods Sold and then affects other amounts reported lower in the income statement.
Required:
- 1. Restate the income statement to reflect LCM valuation of the ending inventory. Apply LCM on an item-by-item basis and show computations.
- 2. Compare and explain the LCM effect on each amount that was changed in requirement 1.
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