ACT 530, Fall 2020 Assignment 6 Inventory Measurement at the Lower of Cost or Market (LCM) LCM rule is an example of conservatism in accounting, and LCM rule is applied in the following steps: 1. Original cost is the original price the company paid when the company bought the inventory, and replacement cost is the current price the company should pay if the company wants to replace the inventory. 2. In order not to over-value the inventory, the lower of (original) cost or market (=replacement cost) is taken at the end of period, and adjusting journal entry is made. 3. Replacement cost is subject to upper limit (-ceiling) and lower limit (=floor) due to the chance of manipulation or reasonableness. 4. After replacement cost is tested to upper limit (-ceiling) and lower limit (-floor), we get designated market value. 5. Designated market is compared to original cost, and the lower of two is taken for the value of the inventory 6. Upper limit (=cciling) is calculated as expected selling price minus estimated disposal cost, which is what the company gets when they sell the inventory. Upper limit is called "net realizable value' (NRV). Estimated disposal cost is the cost the company incurs in disposing the old inventory they take from the customer (old furniture in this assignment). Replacement cost can be up to this ceiling (NRV). 7. Lower limit (-floor) is calculated as 'net realizable value' (NRV) minus normal profit on sales. Normal profit on sales is calculated as expected selling price times the percentage of normal profit on sales. It is not considered reasonable if the company says they can buy the inventory at lower price than this. Imagine that inventory priced at lower than this may be manufactured using illegal child labor or other inappropriate ways. Replacement cost can be as low as this floor (NRV minus normal profit margin). 8. If replacement cost is already between ceiling and floor, the replacement cost is the designated market itself. 9. So, designated market is the replacement cost up to ceiling (net realizable value) and down to floor (net realizable value minus normal profit margin). Assignment 6 At December 31, 2018, the inventory of Dwyer Furniture Co. consisted of four products. For each product, the following information is provided. Replacement Estimated Expected Normal Profit Product Original Cost Cost Disposal Cost Selling Price on Sales $25.00 $22.00 $6.50 $40.00 20% $42.00 $40.00 $12.00 $48.00 25% $120.00 $115.00 $25.00 $190.00 30% B D $18.00 $15.80 $3.00 $26.00 10% Using the lower-of-cost-or-market approach on an individual-item basis, compute the inventory value that should be reported for each product on December 31, 2018, balance sheet by filling out the table below. (16 points) Product Original Cost Replacement Cost Ceiling Floor Designated Market Final Inventory 25.00 22.00 B 42.00 40.00 C 120.00 115.00 D 18.00 15.80 Assignment 7 (10 Points) Name: (first name, middle name, last name) The company produced 1 unit that took 20 direct labor hours. Producing the product is subject to 90% learning curve. 1. How many total direct labor hours does it take to manufacture two units of the product. (Show your work in good form.) 2. How many direct labor hours does it take to manufacture the second unit. (Show your work in good form.) 3. After the company manufactures the two units, let's say the company doubles the production manufacturing the next two units. How many direct labor hours does it take to produce total four units? How many direct labor hours does it take to produce the next two units? Hint: Treat the first two units as one batch, get the time for the first batch, and treat the next two units as the second batch. Then, get average time per batch, total time for the two batches, and how much time for the first batch. (Show your work in good form.) ACT 530-01, Fall 2020 Learning Curve Analysis How It Works? 80% Learning Curve (for example) Let's say it takes 10 direct labor hours to produce 1 unit of product, and let's assume 80% learning curve. Under 80% learning curve, when the production is doubled, which means another unit (total 2 units) is produced. The average time per unit in manufacturing the two units is 80% of the first unit (80% of 10 hours per unit = 8 hours per unit); therefore, total time to manufacture the two units is 8 hours per unit times 2 total units, which equals 16 hours total to manufacture the two units. But, remember that the first unit took 10 direct labor hours. (It doesn't change because it already took the time.) Instead, when another unit is produced (production is doubled), it gets efficient as experience is gained. So, the time it took to manufacture the second unit is just 6 hours (It takes total 16 direct labor hours for two units, the first unit takes 10 direct labor hours, leaving 6 hours for the second unit.) This is how learning curve works. Use this learning curve analysis for Assignment 6. ACT 530, Fall 2020 Assignment 6 Inventory Measurement at the Lower of Cost or Market (LCM) LCM rule is an example of conservatism in accounting, and LCM rule is applied in the following steps: 1. Original cost is the original price the company paid when the company bought the inventory, and replacement cost is the current price the company should pay if the company wants to replace the inventory. 2. In order not to over-value the inventory, the lower of (original) cost or market (=replacement cost) is taken at the end of period, and adjusting journal entry is made. 3. Replacement cost is subject to upper limit (-ceiling) and lower limit (=floor) due to the chance of manipulation or reasonableness. 4. After replacement cost is tested to upper limit (-ceiling) and lower limit (-floor), we get designated market value. 5. Designated market is compared to original cost, and the lower of two is taken for the value of the inventory 6. Upper limit (=cciling) is calculated as expected selling price minus estimated disposal cost, which is what the company gets when they sell the inventory. Upper limit is called "net realizable value' (NRV). Estimated disposal cost is the cost the company incurs in disposing the old inventory they take from the customer (old furniture in this assignment). Replacement cost can be up to this ceiling (NRV). 7. Lower limit (-floor) is calculated as 'net realizable value' (NRV) minus normal profit on sales. Normal profit on sales is calculated as expected selling price times the percentage of normal profit on sales. It is not considered reasonable if the company says they can buy the inventory at lower price than this. Imagine that inventory priced at lower than this may be manufactured using illegal child labor or other inappropriate ways. Replacement cost can be as low as this floor (NRV minus normal profit margin). 8. If replacement cost is already between ceiling and floor, the replacement cost is the designated market itself. 9. So, designated market is the replacement cost up to ceiling (net realizable value) and down to floor (net realizable value minus normal profit margin). Assignment 6 At December 31, 2018, the inventory of Dwyer Furniture Co. consisted of four products. For each product, the following information is provided. Replacement Estimated Expected Normal Profit Product Original Cost Cost Disposal Cost Selling Price on Sales $25.00 $22.00 $6.50 $40.00 20% $42.00 $40.00 $12.00 $48.00 25% $120.00 $115.00 $25.00 $190.00 30% B D $18.00 $15.80 $3.00 $26.00 10% Using the lower-of-cost-or-market approach on an individual-item basis, compute the inventory value that should be reported for each product on December 31, 2018, balance sheet by filling out the table below. (16 points) Product Original Cost Replacement Cost Ceiling Floor Designated Market Final Inventory 25.00 22.00 B 42.00 40.00 C 120.00 115.00 D 18.00 15.80 Assignment 7 (10 Points) Name: (first name, middle name, last name) The company produced 1 unit that took 20 direct labor hours. Producing the product is subject to 90% learning curve. 1. How many total direct labor hours does it take to manufacture two units of the product. (Show your work in good form.) 2. How many direct labor hours does it take to manufacture the second unit. (Show your work in good form.) 3. After the company manufactures the two units, let's say the company doubles the production manufacturing the next two units. How many direct labor hours does it take to produce total four units? How many direct labor hours does it take to produce the next two units? Hint: Treat the first two units as one batch, get the time for the first batch, and treat the next two units as the second batch. Then, get average time per batch, total time for the two batches, and how much time for the first batch. (Show your work in good form.) ACT 530-01, Fall 2020 Learning Curve Analysis How It Works? 80% Learning Curve (for example) Let's say it takes 10 direct labor hours to produce 1 unit of product, and let's assume 80% learning curve. Under 80% learning curve, when the production is doubled, which means another unit (total 2 units) is produced. The average time per unit in manufacturing the two units is 80% of the first unit (80% of 10 hours per unit = 8 hours per unit); therefore, total time to manufacture the two units is 8 hours per unit times 2 total units, which equals 16 hours total to manufacture the two units. But, remember that the first unit took 10 direct labor hours. (It doesn't change because it already took the time.) Instead, when another unit is produced (production is doubled), it gets efficient as experience is gained. So, the time it took to manufacture the second unit is just 6 hours (It takes total 16 direct labor hours for two units, the first unit takes 10 direct labor hours, leaving 6 hours for the second unit.) This is how learning curve works. Use this learning curve analysis for Assignment 6