Chapter 7, Problem 2CP

Evaluating the Income Statement and Income Tax Effects of Lower of Cost or Market/Net Realizable Value

Smart Company prepared its annual financial statements dated December 31. The company reported its inventory using the FIFO inventory costing method and failed to evaluate its net realizable value at December 31. The preliminary income statement follows:

Assume you have been asked to restate the financial statements to incorporate LCM/NRV. You have developed the following data relating to the ending inventory:

TIP: Inventory write-downs do not affect the cost of goods available for sale. Instead, the effect of the write-down is to reduce ending inventory, which increases Cost of Goods Sold and then affects other amounts in the income statement.

Required:

1. 1. Restate the income statement to reflect LCM/NRV valuation of the ending inventory. Apply LCM/NRV on an item-by-item basis and show computations.
2. 2. Compare and explain the LCM/NRV effect on each amount in the income statement that was changed in requirement 1.