Question

Garcia Home Improvement Company installs replacement siding, windows, and louvered glass doors for single-family homes and condominium complexes. The company is in the process of preparing its annual financial statements for the fiscal year ended May 31, 2017. Jim Alcide, controller for Garcia, has gathered the following data concerning inventory. At May 31, 2017, the balance in Garcia’s Raw Materials Inventory account was \(408,000, and Allowance to Reduce Inventory to NRV had a credit balance of \)27,500. Alcide summarized the relevant inventory cost and market data at May 31, 2017, in the schedule below. Alcide assigned Patricia Devereaux, an intern from a local college, the task of calculating the amount that should appear on Garcia’s May 31, 2017, financial statements for inventory under the LCNRV rule as applied to each item in inventory. Devereaux expressed concern over departing from the historical cost principle. Net Realizable Cost Sales Price Value Aluminum siding \( 70,000 \) 64,000 \( 56,000 Cedar shake siding 86,000 94,000 84,800 Louvered glass doors 112,000 186,400 168,300 Thermal windows 140,000 154,800 140,000 Total \)408,000 \(499,200 \)449,100 Instructions (a) Determine the proper balance in Allowance to Reduce Inventory to NRV at May 31, 2017. (b) For the fiscal year ended May 31, 2017, determine the amount of the gain or loss that would be recorded (using the loss method) due to the change in Allowance to Reduce Inventory to NRV. (c) Explain the rationale for the use of the LCNRV rule as it applies to inventories

Short answer

a. The proper allowance balance equals $15,200.

b. The gain due to the change in allowance equals $12,300.

c. Under the LCNRV method, inventories are recorded at the lowest cost and NRV to report inventory value accurately and to report loss incurred due to a reduction in the inventory.

Step-by-step solution

Calculation of inventory value per LCNRV

Inventory value per LCNRV is calculated as follows:

	Cost	Net Realizable Value	LCNRV
Aluminium siding	$70,000	$56,000	$56,000
Cedar shake siding	86,000	84,800	84,800
Louvered glass doors	112,000	168,300	112,000
Thermal windows	140,000	140,000	140,000
Total			$392,800

Calculation of allowance on May 31, 2017

(a) The allowance on May 31, 2017, is calculated as follows:

$$\begin{gathered} \mathbf{Allowance}\mathbf{=}\mathbf{InventoryatCost}\mathbf{-}\mathbf{LCNRV} \\ \mathbf{=}\mathbf{\$}\mathbf{408}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{\$}\mathbf{392}\mathbf{,}\mathbf{800} \\ \mathbf{=}\mathbf{\$}\mathbf{15}\mathbf{,}\mathbf{200} \end{gathered}$$

Calculation of gain due to change in allowance

(b) Gain due to change in the allowance is calculated as follows:

$$\begin{gathered} \mathbf{Gain}\mathbf{=}\mathbf{AllowanceBalance}\mathbf{-}\mathbf{RequiredBalance} \\ \mathbf{=}\mathbf{\$}\mathbf{27}\mathbf{,}\mathbf{500}\mathbf{-}\mathbf{\$}\mathbf{15}\mathbf{,}\mathbf{200} \\ \mathbf{=}\mathbf{\$}\mathbf{12}\mathbf{,}\mathbf{300} \end{gathered}$$

Rational of Lower of cost or net realizable value

In case the utility of the inventory is below the original cost of the inventory. Then the business is required to report the loss in the financial statements.

The loss resulting from the reduction in the value of inventory should be recorded in the year for which the loss has been incurred, not in the year of sale. Per lower of cost or net realizable value, inventory is reported at the lower of the two, and loss is recorded as the difference between cost and LCNRV.