馃攳
Lower-of-Cost-or-Market (LCM) and Other Inventory Write-Downs - YouTube
Channel: Learn Accounting with Iana Zemniakova, CPA
[0]
hello everyone and welcome to financial
[2]
accounting today we are going to
[5]
continue talking about inventory and
[7]
we'll discuss lower cost for market and
[10]
other inventory write downs
[13]
[Music]
[29]
before reporting the value for inventory
[31]
on the balance sheet companies consider
[33]
any needed reductions for obsolescence
[38]
we already looked at inventory
[40]
write-offs in the inventory evaluation
[42]
video if you haven't had a chance to
[45]
watch it the link is in the upper right
[47]
corner and in the description to this
[50]
video
[51]
companies take a physical count of
[53]
inventory at least once a year and write
[56]
off all losses due to spoilage
[59]
breakage damage obsolescence and theft
[63]
the physical count helps get records up
[65]
to date to reflect what is actually on
[68]
hand
[69]
if a physical count identifies inventory
[72]
shrinkage an entry is made to debit cost
[75]
of goods sold and credit inventory
[78]
this entry increases cost of goods sold
[81]
an expense account and decreases the
[84]
inventory account
[86]
in addition to shrinkage losses the
[89]
value of inventory may decline because
[91]
the merchandise has become obsolete or
[94]
is unable to be sold for other reasons
[97]
if inventory has become obsolete or is
[100]
otherwise unsellable its carrying amount
[104]
in the accounting records should be
[106]
written down to zero or to its scrap
[109]
value if any
[111]
a write down of inventory reduces both
[114]
the carrying amount of the inventory in
[116]
the balance sheet
[118]
and the net income of the current period
[121]
the net income is reduced because the
[123]
cost of goods sold
[125]
or losses from write down of inventory
[128]
accounts are debited or increased to
[131]
offset the credit to inventory
[134]
we will look at the sample general
[135]
journal entry on the next slide
[139]
the reduction in income is handled in
[142]
the same manner as a shrinkage loss
[144]
if the write down is relatively small
[147]
the loss is charged or debited directly
[150]
to the cost of goods sold account
[152]
if the write down is material in amount
[155]
it is charged to a special loss account
[158]
called loss from write down of inventory
[161]
this account has the same rules as any
[164]
expense account it is increased by debit
[167]
and decreased by credit
[169]
it is reported in the other income or
[172]
loss section
[173]
on the income statement
[176]
let's look at the general journal entry
[178]
we debit a loss from write down of
[180]
inventory and credit inventory
[184]
in addition to recording write-offs due
[187]
to obsolescence
[188]
companies also make sure to adjust the
[191]
inventory value to the lower cost of
[194]
market
[195]
cost is determined using one of the
[197]
methods we already discussed
[200]
specific identification fifo
[203]
lifo or average cost
[206]
market is defined as the current
[208]
replacement price of the inventory
[211]
reports an inventory at the lower cost
[214]
or market follows the conservatism
[217]
principle
[218]
by not overstating the value of assets
[222]
the lower of cost or market rule can be
[225]
used in congestion with any cost
[227]
assumption
[228]
we can apply the lower cost or market
[231]
rule to individual inventory items the
[234]
categories of inventory items or to the
[237]
total inventory
[239]
let's look at the example
[241]
assume that joel's ski shop uses the
[244]
fifo cost flow assumption
[246]
the store sells various lines of
[249]
merchandise with costs and market values
[252]
shown on the screen measured at its fifo
[255]
cost the inventory of joel's ski shop is
[259]
currently recorded at 29 000 in the
[262]
general ledger
[264]
let's apply the lower of cost on market
[267]
rule on the basis of individual items
[270]
first
[271]
look at each item and compare the item
[274]
cost with the market value
[276]
as the name of the rule imply we select
[279]
the lower amount for each item
[282]
for the first line for example we select
[285]
cost of sixteen thousand dollars because
[289]
it is lower than the market value for
[291]
this item
[293]
compare the cost with the market value
[296]
for each item and select the lower
[298]
number for each item
[301]
then add all selected numbers
[304]
the total is 26
[307]
500
[308]
the inventory would be written down to
[311]
twenty six thousand five hundred dollars
[315]
this is accomplished by reducing or
[318]
crediting the merchandise inventory
[320]
account for twenty five hundred dollars
[324]
which is 29 000 less 26
[328]
500
[331]
if we apply the lower of cost to market
[333]
rule on the basis of inventory category
[337]
that is ski equipment and ski
[339]
accessories
[340]
we will write down the 29 000
[344]
fifo cost by 1500
[347]
which is 29 000
[349]
less 27
[351]
500
[353]
similarly
[355]
to previous example
[357]
we compare the cost
[358]
with the market value of each category
[361]
and select the lower number for each
[363]
category
[365]
the cost of ski equipment is twenty
[367]
thousand which is lower than the market
[370]
value of twenty one thousand
[372]
therefore we select the cost of twenty
[375]
thousand
[377]
the cost of ski accessories are higher
[379]
than the market value therefore we
[382]
select the market value of 7 500.
[386]
20 000 for the first category plus 7 500
[390]
for the second category is twenty seven
[393]
thousand five hundred dollars
[396]
likewise if the lower of costal market
[399]
rule is applied on the basis of total
[402]
inventory a write down of only 500 is
[405]
required 29 000 less 28 500
[411]
the market value of the total inventory
[414]
is selected because it is lower than the
[417]
cost
[418]
in the financial statements most
[421]
companies state that inventory is valued
[424]
at the lower cost of market
[426]
in an inflationary economy however the
[429]
lower of these two amounts is usually
[431]
cost especially for companies using lifo
[437]
another approach is called lower of cost
[440]
or net realizable value
[442]
if inventory declines in value below its
[445]
original cost for whatever reason a
[448]
company should write down the inventory
[450]
to reflect this loss
[452]
the general rule is to abandon the
[455]
historical cost principle when the
[457]
future utility or revenue producing
[460]
ability of the asset drops below its
[463]
original cost
[465]
in this situation companies write down
[467]
inventory to net realizable value to
[471]
record this loss
[473]
net realizable value is the net amount
[476]
that a company expects to realize from
[479]
the sale of inventory
[481]
it is an estimated selling price
[484]
in the ordinary course of business
[486]
less reasonably predictable costs of
[490]
completion disposal and transportation
[495]
let's look at the example
[497]
mender corporation has unfinished
[499]
inventory with a cost of 950
[503]
a sales value of one thousand dollars
[507]
estimated cost of completion of fifty
[509]
dollars and estimated selling costs of
[512]
two hundred dollars mender's net
[515]
realizable value is computed by
[517]
subtracting estimated cost of completion
[520]
of fifty dollars and estimated cost to
[523]
sell inventory of two hundred dollars
[526]
from the inventory sales value of one
[528]
thousand dollars
[530]
net realizable value is 750 dollars
[535]
manda reports inventory at 750 dollars
[539]
in its income statement manda reports a
[542]
loss
[543]
due to decline of inventory to net
[545]
realizable value of 200 dollars 950
[550]
less 750
[553]
same as with lower cost to market
[556]
lower of cost or net realizable value
[558]
rule can be applied at the individual
[561]
item category or total inventory levels
[566]
let's look at the general journal
[568]
entries to record write-downs of
[570]
inventory
[571]
in both cases inventory is reduced or
[574]
credited if the amount is immaterial the
[578]
debit is to the cost of goods sold
[580]
account
[581]
if the amount is material the account
[584]
called loss due to decline in inventory
[587]
value is debited
[589]
note that losses are recorded in the
[592]
other revenue or expenses section of the
[595]
income statement
[598]
thank you for watching this video i hope
[600]
you found it helpful feel free to share
[602]
it with anyone who is interested in
[605]
learning accounting
[606]
i will see you next week
[611]
[Music]
Most Recent Videos:
You can go back to the homepage right here: Homepage