9 Inventories: Additional Valuation Issues CONCEPTS FOR ANALYSIS 9
CONCEPTS FOR ANALYSIS
CA9-1 (LCNRV) You have been asked by the financial vice president to develop a short presentation on the LCNRV method for inventory purposes. The financial VP needs to explain this method to the president because it appears that a portion of the company’s inventory has declined in value.
Instructions
The financial vice president asks you to answer the following questions.
(a) What is the purpose of the LCNRV method?
(b) What is meant by “net realizable value”?
(c) Do you apply the LCNRV method to each individual item, to a category, or to the total of the inventory? Explain.
(d) What are the potential disadvantages of the LCNRV method?
CA9-2 ETHICS (LCNRV) The net realizable value of Lake Corporation’s inventory has declined below its cost. Allyn Conan, the controller, wants to use the loss method to write down inventory because it more clearly discloses the decline in the net realizable value and does not distort the cost of goods sold. His supervisor, financial vice president Bill Ortiz, prefers the costof- goods-sold method to write down inventory because it does not call attention to the decline in net realizable value.
Instructions
Answer the following questions.
(a) What, if any, is the ethical issue involved?
(b) Is any stakeholder harmed if Bill Ortiz’s preference is used?
(c) What should Allyn Conan do?
CA9-3 (LCNRV) 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’s 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?
CA9-4 (LCNRV) 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’s 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?
CA9-5 WRITING (Retail Inventory Method) Saurez Company, your client, manufactures paint. The company’s president,
Maria Saurez, has decided to open a retail store to sell Saurez paint as well as wallpaper and other supplies that would be purchased from other suppliers. She has asked you for information about the conventional retail method of pricing inventories at the retail store.
Instructions
Prepare a report to the president explaining the retail method of pricing inventories. Your report should include the following points.
(a) Description and accounting features of the method.
(b) The conditions that may distort the results under the method.
(c) A comparison of the advantages of using the retail method with those of using cost methods of inventory pricing.
(d) The accounting theory underlying the treatment of net markdowns and net markups under the method.
(AICPA adapted)
CA9-6 (Cost Determination, LCM, Retail Method) Olson Corporation, a retailer and wholesaler of national brand-name household lighting fixtures, purchases its inventories from various suppliers.
Instructions
(a) (1) What criteria should be used to determine which of Olson’s costs are inventoriable?
(2) Are Olson’s administrative costs inventoriable? Defend your answer.
(b) (1) Olson uses the lower-of-cost-or-market rule for its wholesale inventories. What are the theoretical arguments for that rule?
(2) The replacement cost of the inventories is below the net realizable value less a normal profit margin, which, in turn, is below the original cost. What amount should be used to value the inventories? Why?
(c) Olson calculates the estimated cost of its ending inventories held for sale at retail using the conventional retail inventory method. How would Olson treat the beginning inventories and net markdowns in calculating the cost ratio used to determine its ending inventories? Why?
(AICPA adapted)
CA9-7 ETHICS (Purchase Commitments) Prophet Company signed a long-term purchase contract to buy timber from the U.S.
Forest Service at $300 per thousand board feet. Under these terms, Prophet must cut and pay $6,000,000 for this timber during the next year. Currently, the market value is $250 per thousand board feet. At this rate, the market price is $5,000,000. Jerry Herman, the controller, wants to recognize the loss in value on the year-end financial statements, but the financial vice president, Billie Hands, argues that the loss is temporary and should be ignored. Herman notes that market value has remained near $250 for many months, and he sees no sign of significant change.
Instructions
(a) What are the ethical issues, if any?
(b) Is any particular stakeholder harmed by the financial vice president’s decision?
(c) What should the controller do?
