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Chapter 9: Q4CA. (page 489)

Steele Corporation purchased a significant amount of raw materials inventory for a new product that it is manufacturing. Steele uses the lower-of-average-cost-or-net realizable value (LCNRV) rule for these raw materials. The net realizable value of the raw materials is below the original cost. 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) (1) At which amount should Steele鈥檚 raw materials inventory be reported on the balance sheet? Why? (2) In general, why is the LCNRV rule used to report inventory? (b) What would have been the effect on ending inventory and cost of goods sold had Steele used the LIFO inventory method instead of the average-cost inventory method for the raw materials? Why?

Short Answer

Expert verified
  1. The raw materials will be reported at net realizable value.
  2. To record inventories correctly and record loss arising due to inventory decline.
  3. The cost of goods sold will be lower, and ending inventory will be higher.

Step by step solution

01

Reporting of raw materials

The net realizable value of the raw material is below the original cost. Hence per the lower-of-cost or market-value method, raw materials will be reported at net realizable value.

02

Reason to use LCNRV for the inventory

The LCNRV method allows the business to record the inventories at the lowest of costs or the net realizable value. Through which inventories are recorded per their utility value and loss resulting from the decline in inventory value recorded in the year of loss.

03

Reason to use LCNRV for the inventory

Under the LIFO method, recent inventories purchased are sold first. Per the given case, prices are decreasing with subsequent purchases. The cost of goods sold will include inventories purchased at a lower price, which will result in a lower cost of goods sold. However, ending inventory will constitute inventory purchased at higher prices; hence it will be higher.

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Most popular questions from this chapter

Dover Company began operations in 2017 and determined its ending inventory at cost and at LCNRV at December 31, 2017, and December 31, 2018. This information is presented below. Cost Net Realizable Value 12/31/17 \(346,000 \)322,000 12/31/18 410,000 390,000Prepare the journal entries required at December 31, 2017, and December 31, 2018, assuming that the inventory is recorded at LCNRV and a perpetual inventory system using the cost-of-goods-sold method is used. (b) Prepare journal entries required at December 31, 2017, and December 31, 2018, assuming that the inventory is recorded at cost and a perpetual system using the loss method is used. (c) Which of the two methods above provides the higher net income in each year?

On April 15, 2018, fire damaged the office and warehouse of Stanislaw Corporation. The only accounting record saved was the general ledger, from which the balance sheet data below was prepared. STANISLAW CORPORATION MARCH 31, 2018 Dr. Cr. Cash \( 20,000 Accounts receivable 40,000 Inventory, December 31, 2017 75,000 Land 35,000 Buildings 110,000 Accumulated depreciation \) 41,300 Equipment 3,600 Accounts payable 23,700 Other accrued expenses 10,200 Common stock 100,000 Retained earnings 52,000 Sales revenue 135,000 Purchases 52,000 Miscellaneous expense 26,600 . \(362,200 \)362,200The following data and information have been gathered. 1. The fiscal year of the corporation ends on December 31. 2. An examination of the April bank statement and canceled checks revealed that checks written during the period April 1鈥�15 totaled \(13,000: \)5,700 paid to accounts payable as of March 31, \(3,400 for April merchandise shipments, and \)3,900 paid for other expenses. Deposits during the same period amounted to \(12,950, which consisted of receipts on account from customers with the exception of a \)950 refund from a vendor for merchandise returned in April. 3. Correspondence with suppliers revealed unrecorded obligations at April 15 of \(15,600 for April merchandise shipments, including \)2,300 for shipments in transit (f.o.b. shipping point) on that date. 4. Customers acknowledged indebtedness of \(46,000 at April 15, 2018. It was also estimated that customers owed another \)8,000 that will never be acknowledged or recovered. Of the acknowledged indebtedness, \(600 will probably be uncollectible. 5. The companies insuring the inventory agreed that the corporation鈥檚 fire-loss claim should be based on the assumption that the overall gross profit rate for the past 2 years was in effect during the current year. The corporation鈥檚 audited financial statements disclosed this information: Year Ended December 31 2017 2016 Net sales \)530,000 \(390,000 Net purchases 280,000 235,000 Beginning inventory 50,000 66,000 Ending inventory 75,000 50,000 6. Inventory with a cost of \)7,000 was salvaged and sold for $3,500. The balance of the inventory was a total loss. Instructions Prepare a schedule computing the amount of inventory fire loss. The supporting schedule of the computation of the gross profit should be in good form.

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鈥檚 fiscal year, November 30, 2017, are shown below. The inventories are stated at cost before any year-end adjustments. Finished goods \(647,000 Work in process 112,500 Raw materials 264,000 Factory supplies 69,000 The following information relates to Maddox鈥檚 inventory and operations. 1. The finished goods inventory consists of the items analyzed below. Cost NRV Down tube shifter Standard model \) 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鈥檚 financial statements taken as a whole. Instructions (a) Prepare the inventory section of Maddox鈥檚 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鈥檚 inventories is less than cost. Explain how this decline would be presented in Maddox鈥檚 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鈥檚 financial statements prepared for the fiscal year ended November 30, 2017.

Fosbre Corporation鈥檚 April 30 inventory was destroyed by fire. January 1 inventory was \(150,000, and purchases for January through April totaled \)500,000. Sales revenue for the same period was $700,000. Fosbre鈥檚 normal gross profit percentage is 35% on sales. Using the gross profit method, estimate Fosbre鈥檚 April 30 inventory that was destroyed by fire.

Gross Profit Method) Each of the following gross profit percentages is expressed in terms of cost. 1. 20%. 3. 331 /3%. 2. 25%. 4. 50%. Instructions Indicate the gross profit percentage in terms of sales for each of the above.
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