- Carson Industries has three inventory items at year-end. Item X costs $12,000 with NRV of $11,200. Item Y costs $8,500 with NRV of $9,100. Item Z costs $15,300 with NRV of $14,800. If Carson applies the lower of cost or NRV method on an individual item basis, what total adjustment to cost of goods sold is required?
Answer: Increase cost of goods sold by $1,300 to reflect the total write-down needed
When applying LCM on an individual item basis, each item is evaluated separately. Item X requires a write-down of $800 ($12,000 - $11,200). Item Y has NRV exceeding cost by $600, but no write-up is recorded under LCM. Item Z requires a write-down of $500 ($15,300 - $14,800). Total write-downs = $800 + $500 = $1,300, increasing COGS. Choice B incorrectly nets favorable and unfavorable differences. Choice C incorrectly calculates the net effect. Choice D incorrectly offsets the Item Y favorable difference against required write-downs.
- Coastal Distributors applies LCM using the individual item approach. At year-end, they have the following inventory: Product A (cost $45,000, NRV $43,200), Product B (cost $32,000, NRV $35,100), Product C (cost $28,500, NRV $26,800). The company uses the direct method to record write-downs. Which journal entry should be recorded?
Answer: Dr. Cost of Goods Sold $3,500; Cr. Inventory $3,500
When you encounter Lower of Cost or Market (LCM) problems using the individual item approach, you need to compare cost versus net realizable value (NRV) for each product separately, then record any necessary write-downs.
Let's apply LCM to each item: Product A has cost of $45,000 but NRV of only $43,200, so it must be written down by $1,800 ($45,000 - $43,200). Product B's cost of $32,000 is below its NRV of $35,100, so no adjustment is needed. Product C has cost of $28,500 but NRV of only $26,800, requiring a write-down of $1,700 ($28,500 - $26,800).
Total write-down needed: $1,800 + $1,700 = $3,500.
Under the direct method, you reduce inventory directly and recognize the loss in Cost of Goods Sold. The correct entry is: Dr. Cost of Goods Sold $3,500; Cr. Inventory $3,500.
Answer choice A incorrectly calculates the write-down as $4,800 (likely using Product A's full cost instead of the write-down amount) and incorrectly shows a gain on recovery, which doesn't apply here. Answer choice B uses the correct $3,500 amount but incorrectly debits a separate Loss account rather than Cost of Goods Sold as required by the direct method. Answer choice C makes the same $4,800 calculation error as choice A and splits the credit incorrectly.
Remember: Under the direct method for LCM, always debit Cost of Goods Sold (not a separate loss account) and credit Inventory directly for the total write-down amount.
- Hammond Industries recorded a $25,000 inventory write-down in Year 1 when net realizable value fell below cost. In Year 2, market conditions improved and the same inventory now has an NRV that exceeds its original cost by $8,000. The inventory remains unsold at year-end Year 2. What is the appropriate accounting treatment?
Answer: Reverse the Year 1 write-down up to original cost but do not recognize the excess above cost
Under GAAP, inventory write-downs can be reversed but only up to the original cost. The inventory cannot be written up above its historical cost even if NRV exceeds cost. Hammond can reverse the $25,000 write-down from Year 1, but cannot recognize the additional $8,000 that NRV exceeds original cost. Choice A incorrectly allows write-up above cost. Choice B incorrectly suggests recognizing unrealized gains above cost. Choice D incorrectly states that write-downs can never be reversed.
- Rockwell Company's ending inventory includes raw materials costing $35,000 that will be used to manufacture products with an estimated selling price of $78,000. The estimated cost to complete these products is $28,000, and estimated selling costs are $6,500. What amount should be reported for these raw materials?
Answer: $35,000 since the net realizable value exceeds cost for the finished goods
When you encounter inventory valuation questions involving raw materials, you need to apply the lower-of-cost-or-net-realizable-value rule, but there's a crucial distinction for raw materials versus finished goods.
For raw materials, you must calculate the net realizable value based on the finished products they will become. Here's the calculation: The finished goods will sell for $78,000, but you must subtract both completion costs ($28,000) and selling costs ($6,500) to find the net realizable value of $43,500. Since this exceeds the raw materials' cost of $35,000, you report the raw materials at their original cost of $35,000.
Let's examine why the other answers miss the mark. Answer A correctly identifies the $35,000 amount but gives an incomplete explanation—it's not just about obsolescence or damage, but about applying the lower-of-cost-or-NRV rule properly. Answer B uses the net realizable value ($43,500) instead of cost, but since cost is lower, you should use cost. Answer C calculates $71,500 by only subtracting selling costs from the selling price, incorrectly ignoring the $28,000 completion costs required to transform raw materials into sellable products.
Answer D provides both the correct amount ($35,000) and the complete reasoning—the raw materials are valued at cost because their net realizable value (based on the finished goods they'll create) exceeds that cost.
Study tip: For raw materials inventory questions, always calculate NRV using the finished product's selling price minus both completion costs and selling costs, then apply the lower-of-cost-or-NRV rule.
- Westfield Manufacturing uses the lower of cost or net realizable value method for inventory valuation. At year-end, their Widget A inventory has a cost of $45,000 and estimated selling price of $52,000. The estimated cost to complete and sell is $8,500. After recording the appropriate write-down, the company receives a large order that increases the estimated selling price to $58,000 while costs to complete and sell remain unchanged. What is the maximum carrying value of Widget A inventory that can be reported in the subsequent period?
Answer: $45,000, representing the original cost which cannot be exceeded under GAAP
Under GAAP, inventory written down cannot be written back up above its original cost. Initially, NRV was $43,500 ($52,000 - $8,500), requiring a write-down from $45,000. Even though NRV later increases to $49,500 ($58,000 - $8,500), the inventory cannot be valued above the original cost of $45,000. Choice A ignores the cost ceiling rule. Choice C incorrectly suggests taking the higher of cost or NRV after a write-down. Choice D incorrectly uses selling price rather than NRV and misapplies the write-down concept.
- Taylor Manufacturing uses a perpetual inventory system and applies LCM at each reporting date. On March 31, inventory costing $120,000 had NRV of $115,000, requiring a $5,000 write-down. On June 30, the same inventory (still unsold) has NRV of $118,000. On September 30, this inventory has NRV of $125,000. What is the inventory carrying value at September 30?
Answer: $120,000 representing the restoration to original cost as the maximum carrying value
Under the perpetual LCM application, write-downs can be reversed in subsequent periods as NRV recovers, but inventory cannot be carried above its original cost. The March write-down reduced carrying value to $115,000. As NRV increased to $118,000 and then $125,000, the inventory can be written back up, but only to the original cost ceiling of $120,000. Choice B incorrectly stops the recovery at June 30. Choice C violates the cost ceiling principle. Choice D incorrectly maintains the inventory at its lowest point.
- During a physical inventory count, Martinez Company discovers that $18,000 of inventory previously recorded has been damaged and can only be sold as scrap for $3,200. The estimated cost to dispose of this inventory is $800. How should Martinez record this discovery?
Answer: Debit Loss on Inventory Write-down $15,600; Credit Inventory $15,600
The net realizable value is $2,400 ($3,200 scrap value - $800 disposal cost). The write-down needed is $15,600 ($18,000 original cost - $2,400 NRV). The entry debits Loss on Inventory Write-down $15,600 and credits Inventory $15,600. Choice A incorrectly ignores disposal costs in calculating NRV. Choice B writes off the entire inventory cost, ignoring recoverable value. Choice D uses an incorrect multi-credit approach and miscalculates the loss amount.
