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Chapter 9: Q1CA. (page 489)

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?

Short Answer

Expert verified
  1. The LCNRV method is used to report the inventory at a net realizable value to record the loss resulting from a decline in inventory.
  2. Net realizable value is the estimated amount that the business will be able to generate by selling the inventory.
  3. The LCNRV method is applied on an individual basis, category basis, and total inventory basis.
  4. The disadvantages include the override cost principle; the loss related to declining is recorded in the year of loss.

Step by step solution

01

Purpose of LCNRV method

a. Lower-of-cost-or-net- realizable-value (LCNRV) is used to report the inventory at the lowest net realizable value or original cost of the asset. In case the future utility of the inventory reduces due to obsoleteness, deterioration, change in price levels, etc., the inventories are recorded at net realizable value, and loss is recorded for the decline in the inventory.

02

Definition of net realizable value

b. Net reliable value (NRV) is compared with the original cost to measure the inventory per LCNRV. Net realizable is estimated by subtracting the cost of completion, disposal, and transportation from the selling price of the product.

03

Application of LCNRV

c. On an individual basis, the LCNRV approach is applied based on each item produced by the business. Under major categories basis, LCNRV is applied to the major categories of inventories produced by the business. Under the total inventory method, the original cost of total inventory is compared with the NRV of total inventory to apply LCNRV.

04

Disadvantages of LCNRV

d. The disadvantages of LCNRV are as follows:

  • Under the LCNRV method, inventories are reported at lower-of-cost-or-net-realizable-value, which is incorrect as per the cost principle, wherein inventory must be reported at the original cost.
  • The loss related to a decline in inventory value is recorded in the year of reduction, not in the year of sale of inventory.

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Most popular questions from this chapter

(a) Determine the ending inventory under the conventional retail method for the furniture department of Mayron Department Stores from the following data. Cost Retail Inventory, Jan. 1 \( 149,000 \) 283,500 Purchases 1,400,000 2,160,000 Freight-in 70,000 Markups, net 92,000 Markdowns, net 48,000 Sales revenue 2,175,000 (b) If the results of a physical inventory indicated an inventory at retail of $295,000, what inferences would you draw?

Robots, Inc. Robots, Inc. reported the following information regarding 2016–2017 inventory. Robots, Inc. 2017 2016 Current assets Cash \( 153,010 \) 538,489 Accounts receivable, net of allowance for doubtful accounts of \(46,000 in 2017 and \)160,000 in 2016 1,627,980 2,596,291 Inventories (Note 2) 1,340,494 1,734,873 Other current assets 123,388 90,592 Assets of discontinued operations — 32,815 Total current assets 3,244,872 4,993,060 Notes to Consolidated Financial Statements Note 1 (in part): Nature of Business and Significant Accounting Policies Inventories—Inventories are stated at the lower-of-cost-or-market. Cost is determined by the last-in, first-out (LIFO) method. Note 2: Inventories consist of the following. 2017 2016 Raw materials \(1,264,646 \)2,321,178 Work in process 240,988 171,222 Finished goods and display units 129,406 711,252 Total inventories 1,635,040 3,203,652 Less: Amount classified as long-term 294,546 1,468,779 Current portion \(1,340,494 \)1,734,873 Inventories are stated at the lower of cost determined by the LIFO method or market for Robots, Inc. If the FIFO method had been used for the entire consolidated group, inventories after an adjustment to the lower-of-cost-ormarket would have been approximately \(2,000,000 and \)3,800,000 at October 31, 2017 and 2016, respectively. Inventory has been written down to estimated net realizable value, and results of operations for 2017, 2016, and 2015 include a corresponding charge of approximately \(868,000, \)960,000, and \(273,000, respectively, which represents the excess of LIFO cost over market. Inventory of \)294,546 and \(1,468,779 at October 31, 2017 and 2016, respectively, shown on the balance sheet as a noncurrent asset represents that portion of the inventory that is not expected to be sold currently. Reduction in inventory quantities during the years ended October 31, 2017, 2016, and 2015 resulted in liquidation of LIFO inventory quantities carried at a lower cost prevailing in prior years as compared with the cost of fiscal 2014 purchases. The effect of these reductions was to decrease the net loss by approximately \)24,000, \(157,000, and \)90,000 at October 31, 2017, 2016, and 2015, respectively. Instructions (a) Comment on why Robots, Inc., might disclose how its LIFO inventories would be valued under FIFO. (b) Why does the LIFO liquidation reduce operating costs? (c) Comment on whether Robots, Inc. would report more or less income if it had been on a FIFO basis for all its inventory

Maddox Specialty Company, a division of Lost World Inc., manufactures three models of gear shift components for bicycles that are sold to bicycle manufacturers, retailers, and catalog outlets. Since beginning operations in 1993, Maddox has used normal absorption costing and has assumed a first-in, first-out cost flow in its perpetual inventory system. The balances of the inventory accounts at the end of Maddox’s fiscal year, November 30, 2017, are shown below. The inventories are stated at cost before any year-end adjustments. Finished goods \(647,000 Work in process 112,500 Raw materials 264,000 Factory supplies 69,000 The following information relates to Maddox’s inventory and operations. 1. The finished goods inventory consists of the items analyzed below. Cost NRV Down tube shifter Standard model \) 67,500 \( 67,000 Click adjustment model 94,500 89,000 Deluxe model 108,000 110,000 Total down tube shifters 270,000 266,000 Bar end shifter Standard model 83,000 90,050 Click adjustment model 99,000 97,550 Total bar end shifters 182,000 187,600 Head tube shifter Standard model 78,000 77,650 Click adjustment model 117,000 119,300 Total head tube shifters 195,000 196,950 Total fi nished goods \)647,000 \(650,550 2. One-half of the head tube shifter finished goods inventory is held by catalog outlets on consignment. 3. Three-quarters of the bar end shifter finished goods inventory has been pledged as collateral for a bank loan. 4. One-half of the raw materials balance represents derailleurs acquired at a contracted price 20% above the current market price. The NRV of the rest of the raw materials is \)127,400. 5. The total NRV of the work in process inventory is \(108,700. 6. Included in the cost of factory supplies are obsolete items with an historical cost of \)4,200. The market value of the remaining factory supplies is $65,900. 7. Maddox applies the LCNRV method to each of the three types of shifters in finished goods inventory. For each of the other three inventory accounts, Maddox applies the LCNRV method to the total of each inventory account. 8. Consider all amounts presented above to be material in relation to Maddox’s financial statements taken as a whole. Instructions (a) Prepare the inventory section of Maddox’s balance sheet as of November 30, 2017, including any required note(s). (b) Without prejudice to your answer to (a), assume that the NRV of Maddox’s inventories is less than cost. Explain how this decline would be presented in Maddox’s income statement for the fiscal year ended November 30, 2017. (c) Assume that Maddox has a firm purchase commitment for the same type of derailleur included in the raw materials inventory as of November 30, 2017, and that the purchase commitment is at a contracted price 15% greater than the current market price. These derailleurs are to be delivered to Maddox after November 30, 2017. Discuss the impact, if any, that this purchase commitment would have on Maddox’s financial statements prepared for the fiscal year ended November 30, 2017.

At December 31, 2017, Indigo Girls Company has outstanding noncancelable purchase commitments for 36,000 gallons, at \(3.00 per gallon, of raw material to be used in its manufacturing process. The company prices its raw material inventory at cost or market, whichever is lower. Instructions (a) Assuming that the market price as of December 31, 2017, is \)3.30, how would this matter be treated in the accounts and statements? Explain. (b) Assuming that the market price as of December 31, 2017, is \(2.70, instead of \)3.30, how would you treat this situation in the accounts and statements? (c) Give the entry in January 2018, when the 36,000-gallon shipment is received, assuming that the situation given in (b) above existed at December 31, 2017, and that the market price in January 2018 was $2.70 per gallon. Give an explanation of your treatment.

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?
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