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Chapter 9: Q2Q (page 473)

Question:Why are inventories valued at the lower-of-cost-or-net realizable value (LCNRV)? What are the arguments against the use of the LCNRV method of valuing inventories?

Short Answer

Expert verified

The loss related to the decline in the utility of the inventories should be charged against the revenue for the period, not in the year of sale of inventories.

The arguments are:

  • Allocation of the purchase price on the basis of sales value, to the individual items.
  • Purchase commitments accounting

Step by step solution

01

Step-by-step-solutionStep1:

The value of the inventories gets reduced due to obsolescence or deterioration, in this situation inventories cannot be reported at the cost, hence it is important to record the loss related to inventory value reduction in the year which it is incurred.

02

Step 2:

In case multiple units are purchased at a single lump-sum price, then the business allocates uses the sales value basis to allocate the total purchase cost of the inventories.

There is another argument, which is related to accounting for purchase commitments. Some may believe that assets and liabilities should be recorded when the contract is signed, and some other groups may believe that delivery date should be considered to record the assets and liabilities.

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Most popular questions from this chapter

You assemble the following information for Seneca Department Store, which computes its inventory under the dollar-value LIFO method. Cost Retail Inventory on January 1, 2017 \(216,000 \)300,000 Purchases 364,800 480,000 Increase in price level for year 9% Instructions Compute the cost of the inventory on December 31, 2017, assuming that the inventory at retail is (a) \(294,300 and (b) \)365,150.

Question:What approaches may be employed in applying the LCNRV procedure? Which approach is normally used and why?

Accounting, Analysis, and Principles Englehart Company sells two types of pumps. One is large and is for commercial use. The other is smaller and is used in residential swimming pools. The following inventory data is available for the month of March. Units Price per Unit Total Residential Pumps Inventory at Feb. 28: 200 \( 400 \) 80,000 Purchases: March 10 500 \( 450 \)225,000 March 20 400 \( 475 \)190,000 March 30 300 \( 500 \)150,000 Sales: March 15 500 \( 540 \)270,000 March 25 400 \( 570 \)228,000 Inventory at March 31: 500 Commercial Pumps Inventory at Feb. 28: 600 \( 800 \)480,000 Purchases: March 3 600 \( 900 \)540,000 March 12 300 \( 950 \)285,000 March 21 500 \(1,000 \)500,000 Sales: March 18 900 \(1,080 \)972,000 March 29 600 \(1,140 \)684,000 Inventory at March 31: 500 In addition to the above information, due to a downturn in the economy that has hit Englehart’s commercial customers especially hard, Englehart expects commercial pump prices from March 31 onward to be considerably different (and lower) than at the beginning of and during March. Englehart has developed the following additional information. Commercial Pumps Residential Pumps Net realizable value (per unit) \(900 \)580 The normal profit margin is 16.67% of cost. Englehart uses the FIFO accounting method. Accounting (a) Determine the dollar amount that Englehart should report on its March 31 balance sheet for inventory. Assume Englehart applies lower-of-cost-or-net realizable value at the individual product level. (b) Repeat part (a) but assume Englehart applies lower-of-cost-or-net realizable value at the major categories level. Englehart places both commercial and residential pumps into the same (and only) category. Analysis Which of the two approaches above (individual product level or major categories) for applying LCNRV do you think gives the financial statement reader better information? Principles Assume that during April, the net realizable value of commercial pumps rebounds to $1,050. (a) Briefly describe how Englehart will report in its April financial statements the inventory remaining from March 31. (b) Briefly describe the conceptual trade-offs inherent in the accounting in part (a).

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 ?

Riegel Company uses the LCNRV method, on an individual-item basis, in pricing its inventory items. The inventory at December 31, 2017, consists of products D, E, F, G, H, and I. Relevant per unit data for these products appear below. Item DE F GH I Estimated selling price \(120 \)110 \(95 \)90 \(110 \)90 Cost 75 80 80 80 50 36 Cost to complete 30 30 25 35 30 30 Selling costs 10 18 10 20 10 20 Instructions Using the LCNRV rule, determine the proper unit value for balance sheet reporting purposes at December 31, 2017, for each of the inventory items above.
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