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Maddox Specialty Company, a division of Lost World Inc., manufactures three models of gear shift components for bicycles that are sold to bicycle manufacturers, retailers, and catalog outlets. Since beginning operations in 1993, Maddox has used normal absorption costing and has assumed a first-in, first-out cost flow in its perpetual inventory system. The balances of the inventory accounts at the end of Maddox’s fiscal year, November 30, 2017, are shown below. The inventories are stated at cost before any year-end adjustments. Finished goods \(647,000 Work in process 112,500 Raw materials 264,000 Factory supplies 69,000 The following information relates to Maddox’s inventory and operations. 1. The finished goods inventory consists of the items analyzed below. Cost NRV Down tube shifter Standard model \) 67,500 \( 67,000 Click adjustment model 94,500 89,000 Deluxe model 108,000 110,000 Total down tube shifters 270,000 266,000 Bar end shifter Standard model 83,000 90,050 Click adjustment model 99,000 97,550 Total bar end shifters 182,000 187,600 Head tube shifter Standard model 78,000 77,650 Click adjustment model 117,000 119,300 Total head tube shifters 195,000 196,950 Total fi nished goods \)647,000 \(650,550 2. One-half of the head tube shifter finished goods inventory is held by catalog outlets on consignment. 3. Three-quarters of the bar end shifter finished goods inventory has been pledged as collateral for a bank loan. 4. One-half of the raw materials balance represents derailleurs acquired at a contracted price 20% above the current market price. The NRV of the rest of the raw materials is \)127,400. 5. The total NRV of the work in process inventory is \(108,700. 6. Included in the cost of factory supplies are obsolete items with an historical cost of \)4,200. The market value of the remaining factory supplies is $65,900. 7. Maddox applies the LCNRV method to each of the three types of shifters in finished goods inventory. For each of the other three inventory accounts, Maddox applies the LCNRV method to the total of each inventory account. 8. Consider all amounts presented above to be material in relation to Maddox’s financial statements taken as a whole. Instructions (a) Prepare the inventory section of Maddox’s balance sheet as of November 30, 2017, including any required note(s). (b) Without prejudice to your answer to (a), assume that the NRV of Maddox’s inventories is less than cost. Explain how this decline would be presented in Maddox’s income statement for the fiscal year ended November 30, 2017. (c) Assume that Maddox has a firm purchase commitment for the same type of derailleur included in the raw materials inventory as of November 30, 2017, and that the purchase commitment is at a contracted price 15% greater than the current market price. These derailleurs are to be delivered to Maddox after November 30, 2017. Discuss the impact, if any, that this purchase commitment would have on Maddox’s financial statements prepared for the fiscal year ended November 30, 2017.

Step by step solution

01

Inventory section of the balance sheet

a. The inventory section of the balance sheet is as follows:

Maddox Specialty Company
Partial Balance Sheet
November 30, 2017
Current assets
Inventory
Finished goods	$643,000
Work-in-process	108,700
Raw materials	237,400
Factory supplies	64,800	$1,053,900
Total Inventories

Notes to the financial statements:

1. The FIFO method is used to value the inventory at cost. The lower-of-cost or NRV method is applied to value the inventory across all categories.
2. Catalog outlets hold one-half or 50% of the head tube shifters finished goods on a consignment basis.
3. Finished goods as collateral include three quarters or 75% of the bar-end shifter in the bank.

02

Calculation of inventory

Inventory values are calculated as follows:

	Finished Goods	Work-in-Process	Raw Materials	Factory Supplies
Down tube shifters at NRV	$266,000
Bar-end shifters at cost	182,000
Head tube shifters at cost	195,000
Work in process at NRV		$108,700
Derailleurs ($264,000 x ½) / (100%+20%)			$110,000
Remaining items			127,400
Supplies at cost	_______	_______	_______	$64,800
Totals	$643,000	$108,700	$237,400	$64,800

03

Presentation of decline in the income statement

b. If the net realizable value (NRV) of the inventory is less than the cost, then the inventory will be recorded at NRV. In this, inventory will be recorded at a lower price; hence this decline in the inventory will be reported in the income statement as a loss, or this loss amount can be directly included in the cost of goods sold.

04

Presentation of change in commitment value on financial statements

c. If the contract price of the purchase commitment is below the contract’s market value, it will result in a loss when the purchase takes place. This loss is a part of an unrealized loss, which is reported in the income statement. Also, the business is required to report estimated liability arising due to purchase commitment in the balance sheet.

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