Chapter 8, Problem 1P

Inventory Write-Down Palmquist Company has five different inventory items and applies the inventory valuation rules on an individual item basis. The normal markup on all items is 20% of cost. The following information is obtained from the company’s records:

Required:

1. 1. Assume that Palmquist uses the FIFO cost flow assumption. Compute the correct inventory value under the lower of cost or net realizable value rule.
2. 2. Assume that Palmquist uses the LIFO cost flow assumption. Compute the correct inventory value under the lower of cost or market rule.
3. 3. Assume that Palmquist uses IFRS. Compute the correct inventory value under the lower of cost or net realizable value rule.
4. 4. Next Level Explain the differences between the inventory valuations reported under IFRS and U.S. GAAP.

To determine

Calculate the correct value of inventory under LCM or NRV rule (if P uses FIFO method).

Explanation of Solution

Inventory Write-Downs: If the utilizing capacity of inventory by the company drops down below the acquisition cost of inventory, the inventory write-downs occur.

The following are the two situations for the inventory write-downs:

• When the inventory is damaged or is in non-salable state
• When the market value of inventory has dropped below the acquisition cost

FIFO: Under this inventory method, the units that are purchased first are sold first. Thus, it starts from the selling of the beginning inventory, followed by the units purchased in a chronological order of their purchases took place during a particular period.

Calculate the correct value of inventory under LCM or NRV rule (if P uses FIFO method):

If FIFO method is used:

Case	Cost	Net realizable value	Lower of cost or NRV
	($)	($)	($)
1	10.00	9.20	9.20	(NRV)
2	8.00	7.80	7.80	(NRV)
3	15.00	14.00	14.00	(NRV)
4	18.00	17.00	17.00	(NRV)
5	25.00	25.30	25.00	(Cost)

Table (1)

If LCNRV rule is used:

Item	Units	Valuation	Total
	$\left(\text{a}\right)$	$\left(\text{b}\right)$	$\text{c = }\left(\text{a}\times \text{b}\right)$
1	500	9.20	4,600
2	400	7.80	3,120
3	300	14.00	4,200
4	200	17.00	3,400
5	100	25.00	2,500
Total inventory valuation			$17,820

Table (2)

To determine

Calculate the correct value of inventory under LCM or NRV rule (if P uses LIFO method).

Explanation of Solution

LIFO: Under this inventory method, the units that are purchased last are sold first. Thus, it starts from the selling of the units recently purchased and ending with the beginning inventory.

Calculate the correct value of inventory under LCM or NRV rule (if P uses LIFO method):

If LIFO method is used:

Case	Cost	Replacement	NRV	NRV less normal profit margin	Lower of cost or Market
	($)	($)	($)	($)	($)
	$\left(\text{a}\right)$	$\left(\text{b}\right)$	$\left(\text{c}\right)$	$\text{d = }\left(\begin{array}{l}\text{NRV}-\\ \text{20\% on cost}\end{array}\right)$
1	10.00	9.10	9.20	7.20	9.10
2	8.00	8.10	7.80	6.20	7.80
3	15.00	13.50	14.00	11.00	13.50
4	18.00	12.00	17.00	13.40	13.40
5	25.00	25.50	25.30	20.30	25.00

Table (3)

If LCM rule is used:

Item	Units	Valuation	Total
	$\left(\text{a}\right)$	$\left(\text{b}\right)$	$\text{c = }\left(\text{a}\times \text{b}\right)$
1	500	9.10	4,550
2	400	7.80	3,120
3	300	13.50	4,050
4	200	13.40	2,680
5	100	25.00	2,500
Total inventory valuation			$16,900

Table (4)

Working note 1:

Calculate NRV less profit margin for item 1.

$\begin{array}{c}\text{NRV less profit margin for item 1= }\left(\begin{array}{l}\text{NRV}-\\ \text{20\% of cost for item 1}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$9}\text{.20}-\\ \text{20\% }\times \text{\$10}\text{.00}\end{array}\right)\\ =\text{\$9}\text{.20}-\$2.00\\ =\$7.20\end{array}$

Working note 2:

Calculate NRV less profit margin for item 2.

$\begin{array}{c}\text{NRV less profit margin for item 2= }\left(\begin{array}{l}\text{NRV}-\\ \text{20\% of cost for item 2}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$7}\text{.80}-\\ \text{20\% }\times \text{\$8}\text{.00}\end{array}\right)\\ =\text{\$7}\text{.80}-\$1.6\\ =\$6.20\end{array}$

Working note 3:

Calculate NRV less profit margin for item 3.

$\begin{array}{c}\text{NRV less profit margin for item 3= }\left(\begin{array}{l}\text{NRV}-\\ \text{20\% of cost for item 3}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$14}\text{.00}-\\ \text{20\% }\times \text{\$15}\text{.00}\end{array}\right)\\ =\text{\$14}\text{.00}-\$3.00\\ =\$11.00\end{array}$

Working note 4:

Calculate NRV less profit margin for item 4.

$\begin{array}{c}\text{NRV less profit margin for item 4= }\left(\begin{array}{l}\text{NRV}-\\ \text{20\% of cost for item 4}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$17}\text{.00}-\\ \text{20\% }\times \text{\$18}\text{.00}\end{array}\right)\\ =\text{\$17}\text{.00}-\$3.60\\ =\$13.40\end{array}$

Working note 5:

Calculate NRV less profit margin for item 5.

$\begin{array}{c}\text{NRV less profit margin for item 5= }\left(\begin{array}{l}\text{NRV}-\\ \text{20\% of cost for item 5}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$25}\text{.30}-\\ \text{20\% }\times \text{\$25}\text{.00}\end{array}\right)\\ =\text{\$25}\text{.30}-\$5.00\\ =\$20.30\end{array}$

To determine

Calculate the correct value of inventory under lower of cost or market rule (If P uses IFRS):

Explanation of Solution

Lower-of-cost-or-market: The lower-of-cost-or-market (LCM) is a method which requires the reporting of the ending merchandise inventory in the financial statement of a company, either at current market value or at historical cost price of the inventory, whichever is less.

If P uses IFRS:

Item	Cost	NRV	LCM
	($)	($)	($)
1	10.00	9.20	9.20	(NRV)
2	8.00	7.80	7.80	(NRV)
3	15.00	14.00	14.00	(NRV)
4	18.00	17.00	17.00	(NRV)
5	25.00	25.30	25.00	(Cost)

Table (5)

If LCNRV rule is used:

Item	Units	Valuation	Total
	(a)	(b)	(c = a*b)
1	500	9.20	4,600
2	400	7.80	3,120
3	300	14.00	4,200
4	200	17.00	3,400
5	100	25.00	2,500
Total inventory value			$17,820

Table (6)

To determine

Describe the difference between the inventory valuation under U.S. GAAP and IFRS.

Explanation of Solution

Differences between the inventory valuation under U.S. GAAP and IFRS:

• If FIFO method is used, there would not be any difference between IFRS and U.S GAAP. However, the use of LIFO is not allowed by IFRS.
• Hence, IFRS would show the result in market value corresponding to the inventory valuation which is greater than the U.S. GAAP.
• FIFO method will result in lower inventory cost in the balance sheet relative to LIFO. As the inventory price is increasing, the inventory purchased last will have higher price than the inventory purchased first. Thus, under this method, the inventory purchased last with higher price will be sold first, thereby increasing the cost of goods sold. However, FIFO method gives lowest cost of goods sold and highest ending inventory since cost of goods are lower in the beginning because purchases are at lower rate and ending inventory is highest as the ending purchases are at higher rate.