Q. 9-4E - Intermediate Accounting (Kieso)

Question

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 12/31/18 410,000 390,000 Instructions (a) Prepare the journal entries required at December 31, 2017, and December 31, 2018, assuming inventory is recorded at LCNRV and a perpetual inventory system using the cost-of-goods-sold method. (b) Prepare journal entries required at December 31, 2017, and December 31, 2018, assuming inventory is recorded at LCNRV and a perpetual system using the loss method. (c) Which of the two methods above provides the higher net income in each year?

Step-by-Step Solution

Answer

1. Under the cost of goods sold method, the cost of goods sold account will be debited, and the inventory account will be credited by $24,000 in 2017. In 2018, the amount will be $20,000.
2. Under the loss method in 2017, loss due to market decline of inventory is debited, and Allowance to reduce inventory to market is credited by $24,000. In 2018, Allowance to reduce inventory to market will be debited, and Recovery of loss due to market decline of inventory is credited by $4,000.
3. In the year 2018, net income will be higher in both methods.

Calculate decline in the value of inventory in 2017 in 2018

Inventory at cost equals $346,000, and inventory’s net realizable value is $322,000. Per LCNRV, inventory value will be equal to $322,000, as it is the lowest between the two. 

$$\begin{gathered} \mathbf{Decline}\mathbf{ }\mathbf{in}\mathbf{ }\mathbf{inventory}\mathbf{ }\mathbf{=}\mathbf{ }\mathbf{inventory}\mathbf{ }\mathbf{cost}\mathbf{ }\mathbf{-}\mathbf{ }\mathbf{inventory}\mathbf{ }\mathbf{as}\mathbf{ }\mathbf{per}\mathbf{ }\mathbf{LCNRV} \\ \mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{=}\mathbf{\$}\mathbf{346}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{322}\mathbf{,}\mathbf{000} \\ \mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{=}\mathbf{\$}\mathbf{24}\mathbf{,}\mathbf{000} \end{gathered}$$

Inventory at cost equals $410,000, and inventory’s net realizable value is $390,000. Per LCNRV,  inventory value will be equal to $390,000, as it is the lowest between the two. 

$$\begin{gathered} \mathbf{Decline}\mathbf{ }\mathbf{in}\mathbf{ }\mathbf{inventory}\mathbf{ }\mathbf{=}\mathbf{ }\mathbf{inventory}\mathbf{ }\mathbf{cost}\mathbf{ }\mathbf{-}\mathbf{ }\mathbf{inventory}\mathbf{ }\mathbf{as}\mathbf{ }\mathbf{per}\mathbf{ }\mathbf{LCNRV} \\ \mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{=}\mathbf{\$}\mathbf{410}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{390}\mathbf{,}\mathbf{000} \\ \mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{=}\mathbf{\$}\mathbf{20}\mathbf{,}\mathbf{000} \end{gathered}$$

Journal entries in both years using cost of goods sold method

1. Journal entries for both years are as follows:

Date	Accounts	Debit	Credit
12/31/17	Cost of goods sold	$24,000
	Inventory		$24,000
12/31/18	Cost of goods sold	$20,000
	Inventory		$20,000

Journal entries in both years using loss method

1. Journal entries for both years are as follows:

Date	Accounts	Debit	Credit
12/31/17	Loss due to market decline of inventory	$24,000
	Allowance to reduce inventory to market		$24,000
12/31/18	Allowance to reduce inventory to market	$4,000
	Recovery of loss due to market decline of inventory		$4,000

 

Calculation of loss recovery in 2018

Loss recovery in 2018 is calculated as follows: 

$$\begin{gathered} \mathbf{Loss}\mathbf{ }\mathbf{recovery}\mathbf{ }\mathbf{in}\mathbf{ }\mathbf{2018}\mathbf{ }\mathbf{=}\mathbf{ }\mathbf{Decline}\mathbf{ }\mathbf{in}\mathbf{ }\mathbf{2017}\mathbf{ }\mathbf{-}\mathbf{ }\mathbf{Decline}\mathbf{ }\mathbf{in}\mathbf{ }\mathbf{2018} \\ \mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{=}\mathbf{\$}\mathbf{24}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{20}\mathbf{,}\mathbf{000} \\ \mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{ }\mathbf{=}\mathbf{\$}\mathbf{4}\mathbf{,}\mathbf{000} \end{gathered}$$

Effect on net income

(C) In 2017, ending inventory will be recorded at a reduced value of $24,000, which will increase the cost of goods sold, and, overall, will decrease the net income in 2017. 

In 2018, ending inventory will be recorded at a reduced value of $20,000, which will decrease the cost of goods sold, and, overall, will increase the net income in 2018 compared to 2017. This effect is applied to both methods.