HW Chap 9 Day 1
ANSWERS TO QUESTIONS
3. The usual basis for carrying forward the inventory to the next period is cost. Departure from
cost is required when the utility of the goods included in the inventory is less than their
cost. This loss in utility should be recognized as a loss of the current period, the period in
which it occurred. Furthermore, the subsequent period should be charged for goods at an
amount that measures their expected contribution to that period. In other words, the
subsequent period should be charged for inventory at prices no higher than those which
would have been paid if the inventory had been obtained at the beginning of that period.
(Historically, the lower-of-cost-or-market rule arose from the accounting convention of
providing for all losses and anticipating no profits.)
In accordance with the foregoing reasoning, the rule of “cost or market, whichever is lower”
may be applied to each item in the inventory, to the total of the components of each major
category, or to the total of the inventory, whichever most clearly reflects operations. The
rule is usually applied to each item, but if individual inventory items enter into the same
category or categories of finished product, alternative procedures are suitable.
The arguments against the use of the lower-of-cost-or-market method of valuing
inventories include the following:
(a) The method requires the reporting of estimated losses (all or a portion of the excess of
actual cost over replacement cost) as definite income charges even though the losses
have not been sustained to date and may never be sustained. Under a consistent
criterion of realization a drop in replacement cost below original cost is no more a
sustained loss than a rise above cost is a realized gain.
(b) A price shrinkage is brought into the income statement before the loss has been
sustained through sale. Furthermore, if the charge for the inventory write-downs is not
made to a special loss account, the cost figure for goods actually sold is inflated by the
amount of the estimated shrinkage in price of the unsold goods. The title “Cost of
Goods Sold” therefore becomes a misnomer.
(c) The method is inconsistent in application in a given year because it recognizes the
propriety of implied price reductions but gives no recognition in the accounts or
financial statements to the effect of the price increases.
(d) The method is also inconsistent in application in one year as opposed to another
because the inventory of a company may be valued at cost in one year and at market
in the next year.
(e) The lower-of-cost-or-market method values the inventory in the balance sheet
conservatively. Its effect on the income statement, however, may be the opposite.
Although the income statement for the year in which the unsustained loss is taken is
stated conservatively, the net income on the income statement of the subsequent
period may be distorted if the expected reductions in sales prices do not materialize.
(f)
In the application of the lower-of-cost-or-market rule a prospective “normal profit” is
used in determining inventory values in certain cases. Since “normal profit” is an
estimated figure based upon past experiences (and might not be attained in the
future), it is not objective in nature and presents an opportunity for manipulation of the
results of operations.
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HW Chap 9 Day 1
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 9-2
Item
Jokers
Cost
$2,000
Designated
Market
$2,050
Penguins
5,000
4,950
4,950
Riddlers
4,400
4,550
4,400
Scarecrows
3,200
3,070
3,070
LCM
$2,000
BRIEF EXERCISE 9-5
Unrealized Holding Loss—Income (Purchase
Commitments)...............................................................
Estimated Liability on Purchase
Commitments .......................................................
50,000
50,000
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HW Chap 9 Day 1
SOLUTIONS TO EXERCISES
EXERCISE 9-1 (15–20 minutes)
Per Unit
Lower-of-
Cost
$ 95
Market
$100.00
Total
Cost
$ 57,000
1,000
60
52.00
60,000
52,000
52,000
112
500
80
76.00
40,000
38,000
38,000
113
200
170
180.00
34,000
36,000
34,000
120
400
205
208.00
82,000
83,200
82,000
121
1,600
16
0.50
25,600
800
800
122
300
240
235.00
72,000
70,500
70,500
$370,600
$340,500
$334,300
Part No.
110
Quantity
600
111
Totals
(a)
$334,300.
(b)
$340,500.
Total
Market
$ 60,000
Cost-orMarket
$ 57,000
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Cost
per
Chair
$54
48
Number
of Chairs
Sold
100
120
Lounge chairs
Chairs
Armchairs
Straight chairs
(800 – 120) X $30 = $20,400
Inventory of straight chairs
200
50
800
Straight chairs
30
80
300
Armchairs
$90
400
Sales
Price per
Chain
Lounge
chairs
Chairs
No. of
Chairs
Total
Cost
6,000
$32,000
$19,200
8,000
$18,000
Sales
$40,000/$100,000 X
$24,000/$100,000 X
$12,800
2,400
3,200
$ 7,200
Gross
Profit
60,000
60,000
$36,000/$100,000 X $60,000
Relative Sales
Price
3,600
4,800
$10,800
Cost of
Chairs
Sold
$100,000
40,000
24,000
$36,000
Total
Sales
Price
$60,000
24,000
14,400
$21,600
Cost
Allocated
to Chairs
30
48
$54
Cost per
Chair
HW Chap 9 Day 1
EXERCISE 9-8 (12–17 minutes)
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HW Chap 9 Day 1
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