Inventory Valuation And Write-Downs - CPA Far

1. What is the net realizable value per tablet?
   Answer: $459.05 Net Realizable Value (NRV) is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Here, the costs of completion are zero. Estimated selling price = $499.00 Costs to sell: Sales commission = 5% of $499 = $24.95 Packaging and shipping = $15.00 Total costs to sell = $24.95 + $15.00 = $39.95 NRV = $499.00 - $39.95 = $459.05.
2. According to U.S. GAAP, what is the carrying value of this inventory item on the December 31, Year 1 balance sheet?
   Answer: $460 For entities using LIFO, inventory is valued at the lower of cost or market (LCM). Cost is $500. 'Market' is the replacement cost ($460), but it cannot exceed a ceiling (Net Realizable Value) or be less than a floor (NRV minus a normal profit margin). - Ceiling (NRV) = Selling Price - Costs to sell = $520 - $40 = $480. - Floor = NRV - Normal Profit Margin = $480 - (10% * $520) = $480 - $52 = $428. Since the replacement cost ($460) is between the floor ($428) and the ceiling ($480), the designated market value is $460. The final carrying value is the lower of cost ($500) or market ($460), which is $460.
3. A company experiences a material inventory write-down due to obsolescence. According to U.S. GAAP, which of the following is a required disclosure related to this event?
   Answer: The amount of the write-down, either separately disclosed or included in cost of goods sold, and the circumstances that led to it. U.S. GAAP requires that if a material amount of inventory is written down, the financial statement notes should disclose the amount of the loss and the circumstances that caused it. The loss can be reported as a separate line item in the income statement or included as part of the cost of goods sold, but its nature should be explained.
4. Which of the following statements correctly differentiates the application of the lower of cost or net realizable value (LCNRV) rule from the lower of cost or market (LCM) rule under U.S. GAAP?
   Answer: LCM defines 'market' as replacement cost subject to a ceiling and a floor, while LCNRV directly uses net realizable value. The primary difference lies in how the 'market' or 'net realizable value' side of the comparison is determined. The LCNRV rule, used for FIFO and weighted-average methods, is a direct comparison of cost to net realizable value. The LCM rule, used for LIFO and retail inventory methods, is more complex; it compares cost to a 'market' value, which is replacement cost constrained by a ceiling (NRV) and a floor (NRV less normal profit).
5. Under U.S. GAAP, at what amount should the raw materials inventory be reported?
   Answer: $170,000, because the finished goods are expected to sell at a loss. Under U.S. GAAP, raw materials are generally not written down below cost unless the finished goods into which they will be incorporated are expected to be sold at a loss. In this case, since the finished product is expected to be sold for less than its cost, the raw materials should be written down to their replacement cost of $170,000. This reflects the diminished utility of the materials when the finished goods cannot recover the full cost of the raw materials.
6. What is the effect of this omission on the company's year-end financial statements, assuming the error is not corrected?
   Answer: Cost of goods sold is understated and retained earnings are overstated. Failing to record a write-down means that the ending inventory (an asset) is overstated. According to the COGS formula (Beginning Inventory + Purchases - Ending Inventory), an overstated ending inventory leads to an understated Cost of Goods Sold. An understated COGS results in overstated gross profit and net income. Overstated net income leads to overstated retained earnings. Therefore, COGS is understated and retained earnings are overstated.
7. Sunset Distributors uses the FIFO method and applies lower of cost and net realizable value on an item-by-item basis. During 2024, the company wrote down Product Y inventory by $45,000 due to market decline. In 2025, market conditions improved, and the net realizable value of the remaining Product Y inventory increased by $60,000 from its previously written-down value. The recovery would not cause the inventory to exceed its original cost. How should Sunset account for this recovery in 2025?
   Answer: Recognize a $45,000 gain in the income statement and increase inventory by $45,000 Under US GAAP, inventory write-downs can be recovered in subsequent periods, but the recovery is limited to the amount of the original write-down. Since the original write-down was $45,000, the recovery is limited to $45,000 even though the NRV increased by $60,000. The recovery is recognized as a gain in the income statement (typically as a reduction in cost of goods sold) and the inventory carrying amount is increased. Choice A incorrectly places the gain in OCI instead of the income statement. Choice C exceeds the recovery limit by using the full NRV increase. Choice D incorrectly states that recoveries are not permitted under US GAAP (this restriction applies to IFRS for certain write-downs, but US GAAP allows inventory recovery).
8. What is the total value of Catalyst's inventory after applying the LCNRV rule at the category level?
   Answer: $173,000 When applying LCNRV at the category level, the total cost and total NRV for each category are compared, and the lower of the two totals is used for that category's valuation. For Category A: Total Cost = $30,000 + $40,000 = $70,000. Total NRV = $28,000 + $45,000 = $73,000. The lower amount is the total cost, $70,000. For Category B: Total Cost = $50,000 + $60,000 = $110,000. Total NRV = $52,000 + $55,000 = $107,000. The lower amount is the total NRV, $107,000. Total inventory value = Value of Category A + Value of Category B = $70,000 + $107,000 = $177,000.
9. Harbor Industries discovered that inventory purchased in December 2024 for $180,000 had been incorrectly recorded at $150,000 due to a data entry error. This inventory was subsequently sold in January 2025 for $200,000. The error was discovered during the 2025 audit before the 2024 financial statements were issued. Additionally, at December 31, 2024, this same inventory had a net realizable value of $165,000. How should Harbor correct this error in its 2024 financial statements?
   Answer: Increase inventory by $15,000 and decrease retained earnings by $15,000 The inventory was understated by $30,000 ($180,000 - $150,000). However, at December 31, 2024, the inventory must be valued at lower of cost and NRV. Since the corrected cost ($180,000) exceeds NRV ($165,000), the inventory should be written down to $165,000. The net adjustment to inventory is $165,000 - $150,000 = $15,000 increase. This increases inventory by $15,000 and decreases retained earnings by $15,000 (representing the write-down from cost to NRV). Choice A ignores the NRV limitation and uses the full cost correction. Choice C incorrectly assumes no income statement effect. Choice D correctly identifies the inventory adjustment but incorrectly assumes no retained earnings impact.
10. What is the total value at which the Product Gamma inventory should be reported under U.S. GAAP?
    Answer: $47,000 Under U.S. GAAP, inventory is valued at the lower of cost or net realizable value (LCNRV). - Cost: $50,000 - Net Realizable Value (NRV): Selling Price ($55) - Selling Costs ($8) = $47 per unit. Total NRV = $47 × 1,000 units = $47,000 The inventory must be reported at the lower of cost ($50,000) or NRV ($47,000), which is $47,000.
11. What is the total loss from inventory write-down that the company should recognize for the period?
    Answer: $55,000 Inventory valuation is typically applied on an item-by-item or category basis. Increases in NRV for some items cannot offset decreases for others. - For the obsolete batch: Write-down required = Cost ($50,000) - NRV ($5,000) = $45,000. - For the second batch: Write-down required = Cost ($80,000) - NRV ($70,000) = $10,000. - For the remainder: No write-down is needed as NRV exceeds cost. Total loss to be recognized = $45,000 + $10,000 = $55,000.
12. At what value should this inventory item be reported?
    Answer: $75 First, determine the designated market value, which is bounded by the ceiling and floor. - Ceiling (NRV) = Selling price - Disposal costs = $100 - $10 = $90. - Floor = NRV - Normal profit margin = $90 - (20% * $100) = $90 - $20 = $70. - Replacement cost = $82. The market value is the middle of these three: floor ($70), replacement cost ($82), and ceiling ($90). The replacement cost of $82 is between the floor and ceiling, so it is the designated market value. Finally, the inventory is reported at the lower of cost ($75) or market ($82). The lower value is the cost of $75.
13. What is the designated market value that should be used to apply the lower of cost or market rule?
    Answer: $158.50 The designated market value is the middle value of replacement cost, the ceiling (NRV), and the floor (NRV less normal profit). 1. Replacement Cost = $150. 2. Ceiling (NRV) = Selling Price - Selling Costs = $210 - $20 = $190. 3. Floor = NRV - Normal Profit Margin = $190 - (15% * $210) = $190 - $31.50 = $158.50. The three values are $150 (Replacement Cost), $158.50 (Floor), and $190 (Ceiling). The replacement cost ($150) is below the floor ($158.50). Therefore, the designated market value must be the floor, which is $158.50.
14. At what amount should the company report the obsolete inventory on its balance sheet?
    Answer: $13,000 Obsolete inventory should be written down to its net realizable value (NRV). NRV is the estimated selling price less any costs of disposal. In this case, the estimated selling price is the liquidator's offer of $15,000, and the cost of disposal is the shipping cost of $2,000. Therefore, the NRV is $15,000 - $2,000 = $13,000. The inventory should be reported at this amount.
15. How should the company account for this event in its December 31 financial statements?
    Answer: Disclose the event in the notes to the financial statements but make no adjustment to the inventory balance. This is a non-recognized subsequent event. The condition (the fire) that caused the loss did not exist at the balance sheet date (December 31). Therefore, the financial statements as of December 31 should not be adjusted. However, because the loss is material, the event must be disclosed in the notes to the financial statements to prevent them from being misleading.
16. What amount should the company report for its total ending inventory?
    Answer: $54,000 The LCM rule is applied to each item individually. For each item, 'Market' is replacement cost, bounded by the ceiling (NRV) and the floor (NRV - Normal Profit). Then, the lower of cost or this designated 'Market' is chosen. Item X: Market is $9,000 (since $8,500 <= $9,000 <= $11,000). Lower of Cost ($10,000) or Market ($9,000) is $9,000. Item Y: Market is $19,000 (replacement cost of $19,500 exceeds the ceiling of $19,000, so market = $19,000). Lower of Cost ($20,000) or Market ($19,000) is $19,000. Item Z: Market is $26,000 (since $25,000 <= $26,000 <= $28,000). Lower of Cost ($30,000) or Market ($26,000) is $26,000. Total Inventory Value = $9,000 + $19,000 + $26,000 = $54,000.
17. For the purpose of applying the lower of cost or market rule, what is the designated market value of this inventory item?
    Answer: $85 Under the lower of cost or market (LCM) rule, 'market' is the middle value of three amounts: replacement cost, the ceiling (NRV), and the floor (NRV less a normal profit margin). In this case, the values are: - Ceiling (NRV): $92 - Replacement Cost: $85 - Floor (NRV - normal profit): $78 The replacement cost of $85 falls between the floor ($78) and the ceiling ($92). Therefore, the designated market value is the replacement cost, $85.
18. Which of the following journal entries should Apex record to account for the inventory write-down?
    Answer: Debit Cost of Goods Sold $40,000; Credit Inventory $40,000. The required write-down is the difference between the cost ($250,000) and the lower NRV ($210,000), which is $40,000. The direct method reduces the inventory account directly and typically records the loss as part of the Cost of Goods Sold. Therefore, COGS is debited and Inventory is credited for the amount of the write-down.
19. What is the appropriate accounting treatment for the inventory's recovery in value in Year 2?
    Answer: The carrying amount of the inventory should remain at $80,000; no write-up is permitted. Under U.S. GAAP, once inventory is written down, the new lower value becomes its cost basis for future accounting. Reversals of inventory write-downs are not permitted. Therefore, the carrying amount of the inventory must remain at $80,000 until it is sold, even if its market value subsequently increases.
20. What is the total Cost of Goods Sold that GlobeTech should report on its income statement for the year?
    Answer: $2,350,000 First, calculate the cost of goods sold before any write-down: Beginning Inventory ($800,000) + Purchases ($2,200,000) - Ending Inventory at cost ($700,000) = $2,300,000. Next, calculate the required inventory write-down: Cost ($700,000) - NRV ($650,000) = $50,000. This write-down is typically included in the cost of goods sold. Therefore, the total COGS is $2,300,000 + $50,000 = $2,350,000.

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