EXERCISE 4–2 K2 Sports, a wholesaler that has been in business for two years, purchases its inventories from various suppliers. During these two years, each purchase has been at a lower price than the previous purchase. K2 uses the lower-of-(FIFO)-cost-or-market method to value its inventories.

The original cost of the inventories exceeds its replacement cost, but it is below the net realizable value (also, the net realizable value less a normal profit margin is lower than replacement cost for the inventories).

Required:

a. What criteria should be used in determining costs to include in inventory?

b. Why is the lower-of-cost-or-market rule used in valuing inventory?

c. At what amount should K2 report its inventories on the balance sheet? Explain the application of the lower-of-cost-

or-market rule in this situation.

d. What would be the effect on ending inventories and net income for the second year had K2 used the lower-of-

(average) cost-or-market inventory method instead of the lower-of-(FIFO)-cost-or-market inventory method?

Explain.