Team B Week Three
April 18, 2016
9-2
(Lower-of-Cost-or-Market)
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, 1
2
Garcia Home Improvement Company installs replacement siding, windows, and louvered glass doors for
single-family homes and condominium complexes in northern New Jersey and southern New York. The
company is in the process of preparing its annual financial statements for the fiscal year ended May 31, 2014,
and Jim Alcide, controller for Garcia, has gathered the following data concerning inventory.
At May 31, 2014, the balance in Garcia's Raw Materials Inventory account was $408,000, and Allowance to
Reduce Inventory to Market had a credit balance of $27,500. Alcide summarized the relevant inventory cost
and market data at May 31, 2014, in the schedule below.
Alcide assigned Patricia Devereaux, an intern from a local college, the task of calculating the amount that
should appear on Garcia's May 31, 2014, financial statements for inventory under the lower-of-cost-or-market
rule as applied to each item in inventory. Devereaux expressed concern over departing from the historical cost
principle.
Cost Replacement Cost Sales Price Net Realizable Value Normal Profit
Aluminum siding $ 70,000 $ 62,500 $ 64,000 $ 56,000 $ 5,100
Cedar shake siding 86,000 79,400 94,000 84,800 7,400
Louvered glass 112,000 124,000 186,400 168,300 18,500
doors
Thermal windows 140,000 126,000 154,800 140,000 15,400
Total $408,000 $391,900 $499,200 $449,100 $46,400
Instructions
(a) 1. Determine the proper balance in Allowance to Reduce Inventory to Market at May 31, 2014.
Inventory Cost $408,000
LCL Valuation $373,400
Allowance at May 31, 2014 $34,600
2. For the fiscal year ended May 31, 2014, determine the amount of the gain or loss that would be
recorded due to the change in Allowance to Reduce Inventory to Market.
Balance Prior to Adjustment $27,500
Required Balance $34,600
Loss to be Recorded ($7,100)
(b) Explain the rationale for the use of the lower-of-cost-or-market rule as it applies to inventories.
(CMA adapted)
The use of the lower of cost or market (LCM) rule is based on both the matching principal and the
concept of conservatism. The matching principal applies because the application of the LCM rule allows
for the recognition of a decline in the utility (value) of inventory as a loss in the period in which the
decline takes place.
The departure from the cost principal for inventory valuation is permitted on the basis of conservatism.
The general rule is that the historical cost principal is abandoned when the future utility of an asset is no
longer as great as its original cost
P94. (Gross Profit Method)
5
Eastman Company lost most of its inventory in a fire in December just before the yearend physical
This study source was downloaded by 100000858936669 from CourseHero.com on 01-12-2023 07:24:06 GMT -06:00
https://www.coursehero.com/file/14323037/Team-B-week-3-assignment-1/
April 18, 2016
9-2
(Lower-of-Cost-or-Market)
This study source was downloaded by 100000858936669 from CourseHero.com on 01-12-2023 07:24:06 GMT -06:00
https://www.coursehero.com/file/14323037/Team-B-week-3-assignment-1/
, 1
2
Garcia Home Improvement Company installs replacement siding, windows, and louvered glass doors for
single-family homes and condominium complexes in northern New Jersey and southern New York. The
company is in the process of preparing its annual financial statements for the fiscal year ended May 31, 2014,
and Jim Alcide, controller for Garcia, has gathered the following data concerning inventory.
At May 31, 2014, the balance in Garcia's Raw Materials Inventory account was $408,000, and Allowance to
Reduce Inventory to Market had a credit balance of $27,500. Alcide summarized the relevant inventory cost
and market data at May 31, 2014, in the schedule below.
Alcide assigned Patricia Devereaux, an intern from a local college, the task of calculating the amount that
should appear on Garcia's May 31, 2014, financial statements for inventory under the lower-of-cost-or-market
rule as applied to each item in inventory. Devereaux expressed concern over departing from the historical cost
principle.
Cost Replacement Cost Sales Price Net Realizable Value Normal Profit
Aluminum siding $ 70,000 $ 62,500 $ 64,000 $ 56,000 $ 5,100
Cedar shake siding 86,000 79,400 94,000 84,800 7,400
Louvered glass 112,000 124,000 186,400 168,300 18,500
doors
Thermal windows 140,000 126,000 154,800 140,000 15,400
Total $408,000 $391,900 $499,200 $449,100 $46,400
Instructions
(a) 1. Determine the proper balance in Allowance to Reduce Inventory to Market at May 31, 2014.
Inventory Cost $408,000
LCL Valuation $373,400
Allowance at May 31, 2014 $34,600
2. For the fiscal year ended May 31, 2014, determine the amount of the gain or loss that would be
recorded due to the change in Allowance to Reduce Inventory to Market.
Balance Prior to Adjustment $27,500
Required Balance $34,600
Loss to be Recorded ($7,100)
(b) Explain the rationale for the use of the lower-of-cost-or-market rule as it applies to inventories.
(CMA adapted)
The use of the lower of cost or market (LCM) rule is based on both the matching principal and the
concept of conservatism. The matching principal applies because the application of the LCM rule allows
for the recognition of a decline in the utility (value) of inventory as a loss in the period in which the
decline takes place.
The departure from the cost principal for inventory valuation is permitted on the basis of conservatism.
The general rule is that the historical cost principal is abandoned when the future utility of an asset is no
longer as great as its original cost
P94. (Gross Profit Method)
5
Eastman Company lost most of its inventory in a fire in December just before the yearend physical
This study source was downloaded by 100000858936669 from CourseHero.com on 01-12-2023 07:24:06 GMT -06:00
https://www.coursehero.com/file/14323037/Team-B-week-3-assignment-1/
