Q5P. - Intermediate Accounting (Kieso)

Question

Fiedler Co. follows the practice of valuing its inventory at the lower-ofcost-or-market. The following information is available from the company’s inventory records as of December 31, 2017. Item Quantity Unit Cost Replacement Cost/Unit Estimated Selling Price/Unit Completion & Disposal Cost/Unit Normal Profit Margin/Unit A 1,100 \(7.50 \)8.40 \(10.50 \)1.50 $1.80 B 800 8.20 7.90 9.40 0.90 1.20 C 1,000 5.60 5.40 7.20 1.15 0.60 D 1,000 3.80 4.20 6.30 0.80 1.50 E 1,400 6.40 6.30 6.70 0.70 1.00Instructions Greg Forda is an accounting clerk in the accounting department of Fiedler Co., and he cannot understand why the market value keeps changing from replacement cost to net realizable value to something that he cannot even figure out. Greg is very confused, and he is the one who records inventory purchases and calculates ending inventory. You are the manager of the department and an accountant. (a) Calculate the lower-of-cost-or-market using the individual-item approach. (b) Show the journal entry he will need to make in order to write down the ending inventory from cost to market. (c) Write a memo to Greg explaining what designated market value is as well as how it is computed. Use your calculations to aid in your explanation

Step-by-Step Solution

Answer

(a) The lower-of-cost-or-market using the individual-item approach equals $32,220.

(b) In the journal entry, Loss Due to Decline of Inventory to Market is debited, and allowance to Reduce Inventory to Market is credited by $950, respectively. 

(c) Memorandum is given in step 6. 

Calculation of Lower-of-Cost-or-Market per unit

Lower-of-Cost-or-Market is calculated as follows: 

Item	Unit Cost	Selling Price	Completion & Disposal Cost	Normal Profit Margin	NRV	NRV Less Profit Margin	Replacement Cost	Designated Market value
A	$7.50	$10.50	$1.50	$1.80	$9.00	$7.20	$8.40	$8.40
B	8.20	9.40	0.90	1.20	8.50	7.30	7.90	7.90
C	5.60	7.20	1.15	0.60	6.05	5.45	5.40	5.45
D	3.80	6.30	0.80	1.50	5.50	4.00	4.20	4.20
E	6.40	6.70	0.70	1.00	6.00	5.00	6.30	6.00

Calculation of Lower-of-Cost-or-Market using the individual item

(a) Lower-of-Cost-or-Market is calculated as follows: 

Item	Quantity	Unit Cost	Designated Market value per unit	Lower-of-Cost-or-Market-Value Per Unit	Lower-of-Cost-or-Market-Value
A	1,100	$7.50	$8.40	$7.50	$8,250
B	800	8.20	7.90	7.90	6,320
C	1,000	5.60	5.45	5.45	5,450
D	1,000	3.80	4.20	3.80	3,800
E	1,400	6.40	6.00	6.00	8,400
Total					$32,220

Calculation of total cost of inventory

The total cost of inventory is calculated as follows:

Item	Quantity	Unit Cost	Total Cost
A	1,100	$7.50	$8,250
B	800	8.20	6,560
C	1,000	5.60	5,600
D	1,000	3.80	3,800
E	1,400	6.40	8,960
Total			$33,170

Calculation of reduction in the value of inventory

The reduction in the value of inventory is calculated as follows: 

$\begin{array}{rcl}\mathbf{Reduction}\mathbf{ }\mathbf{in}\mathbf{ }\mathbf{Inventory}& \mathbf{=}& \mathbf{Inventory}\mathbf{ }\mathbf{at}\mathbf{ }\mathbf{Cost}-\mathbf{Lower}\mathbf{-}\mathbf{of}\mathbf{-}\mathbf{Cost}\mathbf{-}\mathbf{or}\mathbf{-}\mathbf{MarketValue}\\ & \mathbf{=}& \mathbf{\$}\mathbf{33}\mathbf{,}\mathbf{170}-\mathbf{\$}\mathbf{32}\mathbf{,}\mathbf{220}\\ & \mathbf{=}& \mathbf{\$}\mathbf{950}\end{array}$

Journal entry of reduction in the value of inventory

(b) Journal entry is shown as follows: 

Date	Description	Debit	Credit
	Loss Due to Decline of Inventory to Market	$950
	Allowance to Reduce Inventory to Market		$950
	(Being inventory reduced to market value)

Journal entry of reduction in the value of inventory

Date: March 11, 2022

To Greg

From XYZ

Subject:  Explanation on designated market value

Under the Lower-of-Cost-or Market-Value method, inventories are recorded at the lowest between the original cost and the designated market value. The designated market value indicates the market value of the inventory. It is measured as the middle value of the three items: replacement costs, Net realizable value, and net realizable value less profit margin. Net realizable value is calculated by subtracting selling and completion costs from the selling price.

In the given case for Item A, the net realizable value is $9.00, calculated by subtracting completion & disposal costs of $1.50 from the selling price of $10.50 per unit. Net realizable value less profit margin is $7.20, which is calculated by subtracting profit margin of $1.80 from NRV of $9.00. In this case designated market value is $8.40, which is the middle value of all three (NRV, NRV less profit margin, and Replacement Costs). In the same way, the designated market value per unit is calculated for all the items. 

Then this value is used to compare with the original cost to measure the inventory value per Lower-of-cost-or-market value.