Question

Know the concept and calculation of lower-of-cost-or-market

Know the concept and calculations for methods of depreciation – S/L, Declining Balance, Units of

Production (Activity), Sum of the Years Digits

Know the concept and calculation for asset impairme

Answer 1

• lower-of-cost-or-market; it is a method of valuing the inventory in cost or market price whichever is lower.

the concept behind this (In case lower market price ) is that the company could have purchased the same item from the market at a lower price so the loss should be recorded as it was because of the faulty decision of the management

it is calculated by finding out which is lower market price or the cost, and the lower price is chosen as the value of the inventory

the formula is cost or market price whichever is lower

• methods of depreciation;

1. Straight-line
2. Declining balance
3. Units of production
4. Sum of years digits

• Straight-line; it is the simplest method by which the expenses are allocated to the years equally.

It is calculated by the formula Depreciation Expense = (Cost – Salvage value) / Useful life

• Declining balance; it is an accelerated depreciation method which is more suitable or asset which lose its value quickly in which the asset is depreciated by the net amount after the depreciation of the earlier years

It is calculated by the formula  Depreciation Expense = (Net Book Value - Residual Value) x %Depreciation Rate

• Units of production; In this method, the depreciation expenses are allocated by the number of units produced i.e, it is apportioned as a part of the number of units produced and as the number o units increases or decreases there is a proportional increase or decrease in the depreciation

It is calculated by the formula Depreciation Expense = (Number of units produced / Life in number of units) x (Cost – Salvage value)

• Sum of years digits; it is a method of accelerated depreciation by which the expenses are higher in the first years and later decreases this works through depreciating the asset's depreciable amount by a depreciation factor unique to each year.

It is calculated by the formula Depreciation Expense = (Remaining life / Sum of the years digits) x (Cost – Salvage value)

• Asset impairment; It is used when the company thinks that the carrying value of an asset on the company balance sheet is less than fair value, GAAP insist the company to lessen the impairment loss (this is only done if the company thinks that the fair value has reduced it is not as the lower of cost or market value)

It is calculated by the formula Impairment loss/cost = Recoverable amount - carrying value