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Chapter 9: Q3CA. (page 489)

Ogala Corporation purchased a significant amount of raw materials inventory for a new product that it is manufacturing. Ogala uses the LCNRV rule for these raw materials. The net realizable value of the raw materials is below the original cost. Ogala uses the FIFO inventory method for these raw materials. In the last 2 years, each purchase has been at a lower price than the previous purchase, and the ending inventory quantity for each period has been higher than the beginning inventory quantity for that period. Instructions (a) At which amount should Ogala鈥檚 raw materials inventory be reported on the balance sheet? Why? (b) In general, why is the LCNRV rule used to report inventory? (c) What would have been the effect on ending inventory and cost of goods sold had Ogala used the average-cost inventory method instead of the FIFO inventory method for the raw materials? Why?

Short Answer

Expert verified
  1. Raw materials will be reported at net realizable value
  2. The LCNRV method is used to report the inventory per its utility value.
  3. Ending inventory will be higher, and the cost of goods sold will be lower than FIFO.

Step by step solution

01

Reporting of raw materials


a. The net realizable value of the inventory is lower than its cost. Hence, per the Lower-of-cost-or-net-realizable-value, it will be reported at net realizable value as it is the lowest.

02

Reason for LCNRV

b. The future utility of the goods decreases, thereby decreasing the value of the goods. The various reasons for the decrease in the value are obsoleteness, physical deterioration, etc. hence, it is important to record the inventory per its benefit that will be received in the future. In the LCNRV method, the lowest value of original cost or NRV is used to report the value of inventory.

03

Effect on ending inventory and cost of goods sold

c. In the case of the FIFO method, in the event of decreasing price, the cost of goods sold will be higher as it will include the inventory purchased early at a higher price. The ending inventory will be lower as it includes the inventory purchased at lower prices. Inventories are valued at the same constant rate when an average method is used. Hence it will result in a higher value of ending inventories as ending inventories are higher, and also cost of goods sold be lower, as fewer units are sold.

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Most popular questions from this chapter

Malone Company determined its ending inventory at cost and at LCNRV at December 31, 2017, December 31, 2018, and December 31, 2019, as shown below. Cost NRV 12/31/17 \(650,000 \)650,000 12/31/18 780,000 712,000 12/31/19 905,000 830,000 Instructions (a) Prepare the journal entries required at December 31, 2018, and at December 31, 2019, assuming that a perpetual inventory system and the cost-of-goods-sold method of adjusting to LCNRV is used. (b) Prepare the journal entries required at December 31, 2018, and at December 31, 2019, assuming that a perpetual inventory is recorded at cost and reduced to LCNRV using the loss method.

Reed Pentak, a finance major, has been following globalization and made the following observation concerning accounting convergence: 鈥淚 do not see many obstacles concerning development of a single accounting standard for inventories.鈥� Prepare a response to Reed to explain the main obstacle to achieving convergence in the area of inventory accounting

Question:Where there is evidence that the utility of inventory goods, as part of their disposal in the ordinary course of business, will be less than cost, what is the proper accounting treatment?

Question:Under what circumstances is relative sales value an appropriate basis for determining the price assigned to inventory?

John Olerud Ltd., a local retailing concern in the Bronx, New York, has decided to change from the conventional retail inventory method to the LIFO retail method starting on January 1, 2018. The company recomputed its ending inventory for 2017 in accordance with the procedures necessary to switch to LIFO retail. The inventory computed was \(212,600. Instructions Assuming that John Olerud Ltd.鈥檚 ending inventory for 2017 under the conventional retail inventory method was \)205,000, prepare the appropriate journal entry on January 1, 2018.
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