Lower of cost or market
• LO9–1
Forester Company has five products in its inventory. Information about the December 31, 2018, inventory follows.
The cost to sell for each product consists of a 15 percent sales commission. The normal profit percentage for each product is 40 percent of the selling price.
Required:
1. Determine the carrying value of inventory at December 31, 2018, assuming the lower of cost or market (LCM) rule is applied to individual products.
2. Determine the carrying value of inventory at December 31, 2018, assuming the LCM rule is applied to the entire inventory. Also, assuming inventory write-downs are usual business practice for Forester, record any necessary year-end
1.
LCM (Lower of Cost or Market) approach: It is an approach that values the inventory at historical cost or lesser than the market replacement cost. The replacement cost refers to the amount that could be realized from the sale of the inventory.
NRV (Net Realizable Value): It refers to an estimated selling price that a company expects to collect in the form of cash from the customers by the sale of inventory. The value is reduced by the expected cost of completion, disposal and transportation. Sales commission and shipping costs also included in the predictable cost.
To Determine: The carrying value of inventory at December 31, 2018 using the lower of cost or market (LCM) for individual products.
Explanation of Solution
The following table shows the carrying value of inventory at December 31, 2018 using the lower of cost or market (LCM) for individual products.
Figure (1)
Explanation:
- NRV is the difference of selling price and selling costs.
- Market Value is the middle of the replacement cost, NRV (ceiling), and NRV- NPM (floor) for each product.
- NRV is Net Realizable Value and NPM is Net Profit Margin.
- When the replacement cost is:
- Less than the (NRV-NPM), the (NRV-NPM) amount is the market value.
- More than the NRV, the NRV amount is the market value
- Between the NRV and the (NRV-NPM), the replacement cost is the market value.
Selling price of the product is less costs to sell. The value of cost to sell consists of a sales commission equal to 15% of selling price.
Working Notes:
Calculate the amount of NRV for product A.
Calculate the amount of NRV for product B.
Calculate the amount of NRV for product C.
Calculate the amount of NRV for product D.
Calculate the amount of NRV for product E.
Determine the difference of NRV and NPM.
Product | NRV ($) | Total Cost ($) | NPM (40% of Total cost) |
NRV-NPM |
A | B | C = B × 40% | A - C | |
A | 13.60 | 16 | 6.40 | 7.20 |
B | 15.30 | 18 | 7.20 | 8.10 |
C | 6.80 | 8 | 3.20 | 3.60 |
D | 5.10 | 6 | 2.40 | 2.70 |
E | 11.05 | 13 | 5.20 | 5.85 |
Table (1)
Therefore, the carrying value of inventory at December 31, 2018 using the lower of cost or market (LCM) for individual products is $28,030.
2.
Explanation of Solution
The total aggregate inventory cost and aggregate inventory market value is $33,600 and $30,390 respectively. Therefore, the carrying value of inventory at December 31, 2018, using the LCM rule applied for entire inventory is $30,390. The amount of inventory write-down is $3,210 ($33,600 - $30,390). The write-down value will be adjusted at the year end.
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Chapter 9 Solutions
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