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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 (=ceiling) 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. rayc u U TUU VUTUS LE LITYISI TUTILCU LATEST 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 A $25.00 $22.00 $6.50 $40.00 20% B $42.00 $40.00 $12.00 $48.00 25% $120.00 $115.00 $25.00 $190.00 30% 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 rayc u VIU TUU VUTUS F LITYISI TUTTILCU JALCS Product Cost A $22.00 Original Cost $25.00 $42.00 $120.00 Selling Price $40.00 $48.00 Disposal Cost $6.50 $12.00 $25.00 $3.00 on Sales 20% 25% B $40.00 $115.00 $190.00 30% D $18.00 $15.80 $26.00 10% Using the lower-of-cost-of-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 A 25.00 22.00 B 42.00 40.00 120.00 115.00 D 18.00 15.80 rayc u U TUU VUTUS LE LITYISI TUTTILCU JALCS