I have tried to figure out how to do this for four days and my textbook does not give an example on how to do this problem.
Lower-of-Cost-or-Market
Corrs Company began operations in 2007 and determined its ending inventory at cost and at lower of cost or market at December 31, 2007, and December 31, 2008. This information is presented below:
Cost Lower of Cost or
Market
12/31/07 $346,000 $327,000
12/31/08 410,000 395,000
Instructions:
a.)Prepare the journal entries required at December 31, 2007 and December 31, 2008, assuming that the inventory is recorded at market, and a perpetual inventory system (direct method) is used.
b.)Prepare journal entries required at December 31, 2007, and December 31, 2008, assuming that the inventory is recorded at cost and an allowance account is adjusted at each year-end under a perpetual system.
c.)Which of the two methods above provides the higher net income in each year?
All I am asking for is somebody to give me an example on how to do this problem after that I should be able to do this.
SraJMcGin,
Thank you for the information, but I still do not know how to set this problem up. The site was no help.
To solve this problem, we will need to understand and apply the Lower of Cost or Market (LCM) rule. The LCM rule states that inventory should be valued at the lower of its cost or its current market value.
Let's go step by step to solve this problem:
a.) Prepare the journal entries required at December 31, 2007, and December 31, 2008, assuming that the inventory is recorded at market, and a perpetual inventory system (direct method) is used.
Since we are using a perpetual inventory system, the cost of goods sold (COGS) is recorded at the time of each sale. We need to compare the cost and market values of the inventory at each year-end.
For December 31, 2007:
The lower value between cost ($346,000) and market ($327,000) is $327,000. Therefore, we need to adjust the inventory value to $327,000.
The journal entry would be:
Debit: Cost of Goods Sold - $19,000
Credit: Inventory - $19,000
For December 31, 2008:
The lower value between cost ($410,000) and market ($395,000) is $395,000. Therefore, we need to adjust the inventory value to $395,000.
The journal entry would be:
Debit: Cost of Goods Sold - $15,000
Credit: Inventory - $15,000
b.) Prepare journal entries required at December 31, 2007, and December 31, 2008, assuming that the inventory is recorded at cost and an allowance account is adjusted at each year-end under a perpetual system.
Since we are now recording the inventory at cost, we need to create an allowance account to adjust any potential loss due to the LCM rule.
For December 31, 2007:
There is no adjustment required because the cost ($346,000) is higher than the market value ($327,000).
No journal entry is needed.
For December 31, 2008:
Again, no adjustment is required because the cost ($410,000) is higher than the market value ($395,000).
No journal entry is needed.
c.) Which of the two methods above provides the higher net income in each year?
In both cases, there is no adjustment made in either year. Therefore, the net income will be the same under both methods.
Remember, the LCM rule is used to value the inventory and determine an appropriate write-down, which impacts the balance sheet rather than the income statement.
I hope this breakdown helps you understand and solve the problem.