Question

The December 31, 2020, Inventory of Balley Inc. consisted of four products, for which certain Information is provided below: Replacement Estimated Expected Product Original Cost Disposal Cost Selling Price A $29.00 $22.00 $6.50 $40.00 B $44.00 $40.00 $8.00 $48.00 с $145.00 $125.00 $25.00 $190.00 $21.00 $15.80 $3.00 $28.00 Cost ** D | Replacement cost: Cost of Bailey to replace/replenish' the unit of inventory. Required: a. Using the lower of cost and NRV approach applied on an individual-item basis, calculate the Inventory valuation that should be reported for each product on December 31, 2020. b. U.S. GAAP allows the use of 'replacement cost' in determining the LCM (Lower of cost and market.) Explain why the cost to 'replace'/buy a unit of raw materials might not be an appropriate amount to use in the LCM calculation, considering the whole purpose of the LCM model in accounting. c. Define NRV.

Answer 1

1. First, determine the purchase cost of inventory.

2. Second, determine the replacement cost of inventory. It is the same as the market value of inventory.

3. Compare replacement cost to net realizable value and net realizable value minus a normal profit margin. If:

• Replacement cost > net realizable value, use net realizable value for replacement cost.
• Replacement cost < net realizable value minus a normal profit margin, use net realizable value minus a profit margin for replacement cost.
• Net realizable value minus a normal profit margin < replacement cost < net realizable value, use replacement cost.

4. Compare the cost of inventory to replacement cost. Lastly, if:

• Cost of inventory < replacement cost, a write-down is not necessary.

Cost of inventory > replacement cost, write-down inventory to replacement cost.

Prodcut A Product B Product C    Product D
a. Cost of the Product 29.0 44.0 145.0 21.0
b. Selling Price   40.0 48.0 190.0 28.0
c. Estimated disposal cost 6.5 8.0 25.0 3.0
d. Net Realisable value {b-c}    33.5 40.0 165.0 25.0
e, Replacement cost 22.0 40.0 125.0 15.8
f. Higher of d or e 33.5 40.0 165.0 25.0
g. value of inventory 29.0 40.0 145.0 21.0
(Lower of a or f )

Total value of inventory = 29+40+145+21
235

Answer for b

In the lower of cost or market inventory valuation method, the inventory of the company purchased at cost is compared against the market value of that inventory. The market value of inventory is essentially the replacement cost of that inventory. For example, if the replacement cost for an inventory of a company is $100, that is the same as saying that the market value of that inventory is $100. However, there are some caveats for replacement value:

1. The replacement cost cannot exceed the net realizable value (NRV).

2. The replacement cost cannot be lower than net realizable value less a normal profit margin.

Net realizable value is the sale price of the inventory minus any costs incurred to prepare the inventory for sale. A normal profit margin is the average spread between the cost and sale price of the inventory. Such caveats for replacement cost establish a floor and ceiling for replacement cost.

Answer for c

Net realisable value is the value of asset that can be realized upon the sale of asset , less reasanable estimate of costs associated with eventual sale or disposal of asset. NRV method is most usefull method in both GAAP and IFRS.