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Chapter 9: Q1CA. (page 489)

You have been asked by the financial vice president to develop a short presentation on the LCNRV method for inventory purposes. The financial VP needs to explain this method to the president because it appears that a portion of the company’s inventory has declined in value. Instructions The financial vice president asks you to answer the following questions. (a) What is the purpose of the LCNRV method? (b) What is meant by “net realizable value”? (c) Do you apply the LCNRV method to each individual item, to a category, or to the total of the inventory? Explain. (d) What are the potential disadvantages of the LCNRV method?

Short Answer

Expert verified
  1. The LCNRV method is used to report the inventory at a net realizable value to record the loss resulting from a decline in inventory.
  2. Net realizable value is the estimated amount that the business will be able to generate by selling the inventory.
  3. The LCNRV method is applied on an individual basis, category basis, and total inventory basis.
  4. The disadvantages include the override cost principle; the loss related to declining is recorded in the year of loss.

Step by step solution

01

Purpose of LCNRV method

a. Lower-of-cost-or-net- realizable-value (LCNRV) is used to report the inventory at the lowest net realizable value or original cost of the asset. In case the future utility of the inventory reduces due to obsoleteness, deterioration, change in price levels, etc., the inventories are recorded at net realizable value, and loss is recorded for the decline in the inventory.

02

Definition of net realizable value

b. Net reliable value (NRV) is compared with the original cost to measure the inventory per LCNRV. Net realizable is estimated by subtracting the cost of completion, disposal, and transportation from the selling price of the product.

03

Application of LCNRV

c. On an individual basis, the LCNRV approach is applied based on each item produced by the business. Under major categories basis, LCNRV is applied to the major categories of inventories produced by the business. Under the total inventory method, the original cost of total inventory is compared with the NRV of total inventory to apply LCNRV.

04

Disadvantages of LCNRV

d. The disadvantages of LCNRV are as follows:

  • Under the LCNRV method, inventories are reported at lower-of-cost-or-net-realizable-value, which is incorrect as per the cost principle, wherein inventory must be reported at the original cost.
  • The loss related to a decline in inventory value is recorded in the year of reduction, not in the year of sale of inventory.

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Most popular questions from this chapter

Barrick Gold Corporation, with headquarters in Toronto, Canada, is the world’s most profitable and largest gold mining company outside South Africa. Part of the key to Barrick’s success has been due to its ability to maintain cash flow while improving production and increasing its reserves of gold-containing property. In the most recent year, Barrick achieved record growth in cash flow, production, and reserves. The company maintains an aggressive policy of developing previously identified target areas that have the possibility of a large amount of gold ore, and that have not been previously developed. Barrick limits the riskiness of this development by choosing only properties that are located in politically stable regions, and by the company’s use of internally generated funds, rather than debt, to finance growth. Using Your Judgment 491 492 Chapter 9 Inventories: Additional Valuation Issues Barrick’s inventories are as follows. Barrick Gold Corporation Inventories (in millions, US dollars) Current Gold in process \(133 Mine operating supplies 82 \)215 Non-current (included in Other assets) Ore in stockpiles \(65 Instructions (a) Why do you think that there are no finished goods inventories? Why do you think the raw material, ore in stockpiles, is considered to be a non-current asset? (b) Consider that Barrick has no finished goods inventories. What journal entries are made to record a sale? (c) Suppose that gold bullion that cost \)1.8 million to produce was sold for $2.4 million. The journal entry was made to record the sale, but no entry was made to remove the gold from the gold in process inventory. How would this error affect the following? Balance Sheet Income Statement Inventory ? Cost of goods sold ? Retained earnings ? Net income ? Accounts payable ? Working capital ? Current ratio ?

Gheorghe Moresan Lumber Company handles three principal lines of merchandise with these varying rates of gross profit on cost. Lumber 25% Millwork 30% Hardware and fittings 40% On August 18, a fire destroyed the office, lumber shed, and a considerable portion of the lumber stacked in the yard. To file a report of loss for insurance purposes, the company must know what the inventories were immediately preceding the fire. No detail or perpetual inventory records of any kind were maintained. The only pertinent information you are able to obtain are the following facts from the general ledger, which was kept in a fireproof vault and thus escaped destruction. Lumber Millwork Hardware Inventory, Jan. 1, 2017 \( 250,000 \) 90,000 $ 45,000 Purchases to Aug. 18, 2017 1,500,000 375,000 160,000 Sales revenue to Aug. 18, 2017 2,080,000 533,000 210,000 Exercises 479 480 Chapter 9 Inventories: Additional Valuation Issues Instructions Submit your estimate of the inventory amounts immediately preceding the fire.

Briefly describe some of the similarities and differences between GAAP and IFRS with respect to the accounting for inventories

Question:The conventional retail inventory method yields results that are essentially the same as those yielded by the lower-of-cost-or-market method. Explain. Prepare an illustration of how the retail inventory method reduces inventory to market.

Wallace Company lost most of its inventory in a fire in December just before the year-end physical inventory was taken. The corporation’s books disclosed the following. Beginning inventory \(170,000 Sales revenue \)650,000 Purchases for the year 390,000 Sales returns 24,000 Purchase returns 30,000 Rate of gross profi t on net sales 40% Merchandise with a selling price of \(21,000 remained undamaged after the fire. Damaged merchandise with an original selling price of \)15,000 had a net realizable value of $5,300. Instructions Compute the amount of the loss as a result of the fire, assuming that the corporation had no insurance coverage.
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