Question

Olson Corporation, a retailer and wholesaler of national brand-name household lighting fixtures, purchases its inventories from various suppliers. Instructions (a) (1) What criteria should be used to determine which of Olson’s costs are inventoriable ? (2) Are Olson’s administrative costs inventoriable ? Defend your answer. (b) (1) Olson uses the lower-of-cost-or-market rule for its wholesale inventories. What are the theoretical arguments for that rule? (2) The replacement cost of the inventories is below the net realizable value less a normal profit margin, which, in turn, is below the original cost. What amount should be used to value the inventories? Why? (c) Olson calculates the estimated cost of its ending inventories held for sale at retail using the conventional retail inventory method. How would Olson treat the beginning inventories and net markdowns in calculating the cost ratio used to determine its ending inventories? Why.

Short answer

All the requirements are given in the steps.

Step-by-step solution

Inventoriable costs

(a1)The costs incurred to prepare inventory for final sale purposesinclude the costs such as freight-in charges, which are incurred on the transportation of inventories purchased.

Treatment of administrative cost

(a2) Administrative costs are the expense incurred on the management part of the business. It is not directly related to the manufacturing or production of goods. Hence, it is not included in the inventory cost, thus not inventoriable.

Arguments against lower-of-cost-or-market rule

(b1) Under this method, the decline in the value of the inventory is recorded as a loss in which the value of inventory decreases.It is against the conservatism principle of the balance sheet, as inventories will be recorded at market value.

Cost of inventory

(b2) Market value of the inventory cannot be less than the net realizable value less profit margin. Hence net realizable value less profit margin will be used to value the inventory.

Treatment of beginning inventories and net markdowns

(c) Beginning inventories are included, and net markdowns are excluded from calculating the cost ratio. Beginning inventories are added to the value of the total goods available for sale.