ACCY 111 Chapter 9
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GAAP defines market for LCM purposes as the inventory's current replacement cost (by purchase or reproduction) except that market should not
- a. exceed the net realizable value (estimated selling price less predicable costs of completion and disposal).
- b. Be less than net realizable value reduced by an allowance for an approximately normal profit margin.
Ceiling and floor
Replacement costs must fall between.
- NRV (net realized value) represents the upper
- NRV-NP (net realizable value less a normal profit margin) is the lower limit.
RC (Replacement costs) represents market, within the rang e.
Designated market value falls in the middle of replacement cost, net realizable value and net realizable value less a normal profit margin.
The designated market value is compared with cost, and the lower of the two is used to value inventory.
Lower of cost or market approach to valuing inventory steps
- Step 1 - Determine designated market (ceiling NRV, Replacement cost, NRV-NP Floor)
- Step 2 - Compare designated market with cost. Choose the lower of cost or market
Formula for determining LCM
- Selling Price xx
- Less: disposal costs xx
- NRV xx
- Less: Normal Profit xx (Selling price x gross profit %)
- NRV-NP xx
When is the gross profit method useful?
- In determining the cost of inventory that has been lost, destroyed, or stolen.
- In estimating inventory and cost of goods sold for interim reports, avoiding the expense of a physical inventory count.
- In auditors' testing of the overall reasonableness of inventory amounts reported by clients.
- In budgeting and forecasting.
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