Question

Dover Company began operations in 2017 and determined its ending inventory at cost and at LCNRV at December 31, 2017, and December 31, 2018. This information is presented below. Cost Net Realizable Value 12/31/17 \(346,000 \)322,000 12/31/18 410,000 390,000Prepare the journal entries required at December 31, 2017, and December 31, 2018, assuming that the inventory is recorded at LCNRV and a perpetual inventory system using the cost-of-goods-sold method is used. (b) Prepare journal entries required at December 31, 2017, and December 31, 2018, assuming that the inventory is recorded at cost and a perpetual system using the loss method is used. (c) Which of the two methods above provides the higher net income in each year?

Short answer

(a) Journal entry is for the cost of goods sold given in Step 2.

(b) Journal entry for loss method given in Step 3.

(c) Both methods will have higher net income in the year 2018

Step-by-step solution

Calculate the reduction in the value of inventory in 2016 and 2017

The reduction in the value of inventory in 2017 is calculated as follows:

$$\begin{gathered} \mathbf{Reduction}\mathbf{}\mathbf{in}\mathbf{}\mathbf{Inventory}\mathbf{=}\mathbf{Inventory}\mathbf{}\mathbf{at}\mathbf{}\mathbf{Cost}-\mathbf{Inventory}\mathbf{}\mathbf{as}\mathbf{}\mathbf{Per}\mathbf{}\mathbf{Lower}\mathbf{-}\mathbf{of}\mathbf{-}\mathbf{Cost}\mathbf{-}\mathbf{or}\mathbf{-}\mathbf{Market} \\ \mathbf{=}\mathbf{\$}\mathbf{346}\mathbf{,}\mathbf{000}-\mathbf{\$}\mathbf{322}\mathbf{,}\mathbf{000} \\ \mathbf{=}\mathbf{\$}\mathbf{24}\mathbf{,}\mathbf{000} \end{gathered}$$

The reduction in the value of inventory in 2018 is calculated as follows: $$\begin{gathered} \mathbf{Reduction}\mathbf{}\mathbf{in}\mathbf{}\mathbf{Inventory}\mathbf{=}\mathbf{Inventory}\mathbf{}\mathbf{a}\mathbf{}\mathbf{Cost}-\mathbf{Inventory}\mathbf{}\mathbf{as}\mathbf{}\mathbf{Per}\mathbf{}\mathbf{Lower}\mathbf{-}\mathbf{of}\mathbf{-}\mathbf{Cost}\mathbf{-}\mathbf{or}\mathbf{-}\mathbf{Market} \\ \mathbf{=}\mathbf{\$}\mathbf{410}\mathbf{,}\mathbf{000}-\mathbf{\$}\mathbf{390}\mathbf{,}\mathbf{000} \\ \mathbf{=}\mathbf{\$}\mathbf{20}\mathbf{,}\mathbf{000} \end{gathered}$$

Journal entries in both years using the cost of goods sold method

(a) Journal entries for both years are as follows:

Date	Accounts	Debit	Credit
12/31/17	Cost of goods sold	$24,000
	Inventory		$24,000
12/31/18	Cost of goods sold	$20,000
	Inventory		$20,000

Journal entries in both years using the loss method

(b) Journal entries for both years are as follows:

Date	Accounts	Debit	Credit
12/31/17	Loss due to market decline of inventory	$24,000
	Allowance to reduce inventory to market		$24,000
12/31/18	Allowance to reduce inventory to market	$4,000
	Recovery of loss due to the market decline of inventory		$4,000

Calculation of loss recovery in 2018

Loss recovery in 2018 is calculated as follows:

$$\begin{gathered} \mathbf{Loss}\mathbf{}\mathbf{Recovery}\mathbf{}\mathbf{in}\mathbf{}\mathbf{2018}\mathbf{=}\mathbf{Reduction}\mathbf{}\mathbf{in}\mathbf{}\mathbf{2017}-\mathbf{Reduction}\mathbf{}\mathbf{in}\mathbf{}\mathbf{2018} \\ \mathbf{=}\mathbf{\$}\mathbf{24}\mathbf{,}\mathbf{000}-\mathbf{\$}\mathbf{20}\mathbf{,}\mathbf{000} \\ \mathbf{=}\mathbf{\$}\mathbf{4}\mathbf{,}\mathbf{000} \end{gathered}$$

Effect on net income

(c) In the year 2017, the ending inventory is recorded at $322,000, which is less than the actual cost of $346,000. Hence it will increase the cost of goods sold and decrease the net income. This scenario applies to both methods.

In the year 2018, beginning inventory equals $322,000 and ending inventory equals $390,000, which will decrease the cost of goods sold and will overall result in increased net income. This effect is applied to both methods.