Inventory Write-Downs

Late in the year, Software City began carrying WordCrafter, a new word processing software program. At December 31, Software Citys perpetual inventory records included the following cost layers in its inventory of WordCrafter programs:

a. At December 31, Software City takes a physical inventory and finds that all 28 units of Word- Crafter are on hand. However, the current replacement cost (wholesale price) of this product is only $250 per unit. Prepare the entries to record:

1. This write-down of the inventory to the lower-of-cost-or-market at December 31. (Company policy is to charge LCM adjustments of less than $2,000 to Cost of Goods Sold and larger amounts to a separate loss account.)

2. The cash sale of 15 WordCrafter programs on January 9, at a retail price of $350 each. Assume that Software City uses the FIFO flow assumption.

b. Now assume that the current replacement cost of the WordCrafter programs is $405 each. A physical inventory finds only 25 of these programs on hand at December 31. (For this part, return to the original information and ignore what you did in part a.)

1. Prepare the journal entry to record the shrinkage loss assuming that Software City uses the FIFO flow assumption.

2. Prepare the journal entry to record the shrinkage loss assuming that Software City uses the LIFO flow assumption.

3. Which cost flow assumption (FIFO or LIFO) results in the lowest net income for the period? Would using this assumption really mean that the companys operations are less efficient? Explain.