To Determine Lower of Cost or Market
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To Determine Lower of Cost or Market. First, Determine “Market”:. Identify Replacement Cost of the Item. This is the amount you would pay to replace the item. Identify the Net Realizable Value of the Item.

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To Determine Lower of Cost or Market

First, Determine “Market”:

  • Identify Replacement Cost of the Item

This is the amount you would pay to replace the item

  • Identify the Net Realizable Value of the Item

This is the amount you could reasonably sell the item for in course of business, minus completion and sales costs.

  • Compute Net Realizable Value minus normal

  • profit margin

This is a floor that is computed to prevent understatement of inventory.

“Market” is the middle of these three values.


To Determine Lower of Cost or Market

Next, Determine New Inventory Value:

Compare “market” to historical cost value

Select the lower value of these two

This can be done at the individual item level, the inventory

category level, or at the total inventory level.


Lower of Cost or Market Example

  • Paterno Motors has the following in inventory:

  • 1 Ford Explorer

  • 1 Toyota Forerunner

  • 1 Dodge Caravan

  • 1 4x4 tire

  • 1 4x4 foglight kit

They also have a 20% normal profit margin above historical cost.


Item-by-Item Method

Assume these numbers are already known.

These must be computed.


Item-by-Item Method

First, determine “market” by taking middle value.


Item-by-Item Method

Next, choose lower of historical cost or “market.”


Item-by-Item Method

Do the same procedures, Item-by-Item.










Category Method

Total up each column within Category. Then apply the same method.






Total Inventory Method

Total all columns then apply same method.




Presenting the Markdown to Market

Assume Paterno chooses Total Inventory Method

(LCM yields ending balance of $53,610)

Need a journal entry to adjust inventory balance down from Historical Cost balance of $57,130 to LCM ending balance of $53,610 (a difference of $3,520).

Two methods of adjustment:

  • Direct method: Adjust directly to Inventory and directly

  • to Cost of Goods Sold

  • Allowance method: Adjust to contra-asset allowance

  • account and to Holding Loss account


Presenting the Markdown to Market

  • Direct Method:

  • Cost of Goods Sold 3,520

  • Inventory 3,520

  • Allowance Method:

  • Inventory Holding Loss 3,520

  • Inventory LCM Allowance 3,520


Sales

Beg Inv.

Purchs.

CoGAS

End Inv.

COGS

Gross Marg.

Stated at LCM

Stated at Historical Cost

Presenting the Markdown to Market

Direct Method

Allowance Method

82,000

82,000

95,000

95,000

20,000

20,000

115,000

115,000

(53,610)

(57,130)

(61,390)

(57,870)

20,610

24,130

(3,520)

Holding Loss

20,610

Adj. Gross Marg.


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