Chapter 7, Problem 7.2CP

Evaluating the Income Statement and Income Tax Effects of Lower of Cost or Market

Smart Company prepared its annual financial statements dated December 31. The company used the FIFO inventory costing method, but it failed to apply LCM to the ending inventory. The preliminary income statement follows:

Sales Revenue		$280,000
Cost of Goods Sold
Beginning Inventory	$30,000
Purchases	182,000
Goods Available for Sale	212,000
Ending Inventory (FIFO cost)	44,000
Cost of Goods Sold		168,000
Gross Profit		112,000
Operating Expenses		61,000
Income from Operations		51,000
Income Tax Expense (30%)		15,300
Net Income		$35,700

Assume that you have been asked to restate the financial statements to incorporate LCM. 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 reported lower in the income statement.

Required:

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