Question

At December 31, 2017, Coburn Corp. has assets of \(10,000,000, liabilities of \)6,000,000, common stock of \(2,000,000 (representing 2,000,000 shares of \)1 par common stock), and retained earnings of \(2,000,000. Net sales for the year 2017 were \)18,000,000, and net income was \(800,000. As auditors of this company, you are making a review of subsequent events on February 13, 2018, and you find the following.

5) Merchandise traded in the open market is recorded in the company’s records at \)1.40 per unit on December 31, 2017. This price had prevailed for 2 weeks, after release of an official market report that predicted vastly enlarged supplies; however, no purchases were made at \(1.40. The price throughout the preceding year had been about \)2, which was the level experienced over several years. On January 18, 2018, the price returned to $2, after public disclosure of an error in the official calculations of the prior December, correction of which destroyed the expectations of excessive supplies. Inventory at December 31, 2017, was on a lower-of-LIFO-cost-or-market basis.

Instructions

State in each case how the 2017 financial statements would be affected, if at all.

Short answer

The market value should be changed from $2.00 to $1.40.

Step-by-step solution

Meaning of LIFO

LIFO is an inventory valuation method in which the last item is sold first. LIFO is not adopted by every business enterprise because at the end of the year items become old and lose value over time.

Explaining the effect in the financial statements

Apply the low-cost-or-market principle to the inventory amount as of December 31, 2017, requiring a market value of $2.00 instead of $1.40. The actual estimate was a temporary error, and no purchases were made at that price.