Question

Olson Corporation, a retailer and wholesaler of national brand-name household lighting fixtures, purchases its inventories from various suppliers.

Instructions: Answer each of the following questions. Your responses need to be in full sentences and answer the question intent fully to receive credit.

A. 1. What criteria should be used to determine which of Olson’s costs are inventoriable?

2. Are Olson’s administrative costs inventoriable? Defend your answer.

B. 1. Olson uses LIFO and the lower-of-cost-or-market rule for its wholesale inventories. What are the theoretical arguments for that rule?

2. The replacement cost of the inventories is below the net realizable value less a normal profit margin, which, in turn, is below the original cost. What amount should be used to value the inventories? Why?

C. Assume instead that Olson calculates the estimated cost of its ending inventories held for sale at retail using the conventional retail inventory method. How would Olson treat the beginning inventories and net markdowns in calculating the cost ratio used to determine its ending inventories? Why?

Answer 1

A)

1) Olson’s inventoriable cost should include all  costs incurred to obtain or produce the end- products & applied to the products the company produces & sells.It includes not only the purchase price of the fixtures but also the other associated costs incurred on the fixtures up to the time they are ready for sale to the customer, for example : purchase cost of goods, inward freight cost, handling, etc.

2)

No, Olson’s administrative costs are inventoriable.It is period cost and do not relate directly to inventories, but are incurred for the benefit of all functions of the business.

B)

1) The lower-of-cost-or-market rule is used for valuing inventories because of the concept of balance sheet conservatism and because the decline in the utility of the inventories below their cost should be recognized as a loss in the current period.

2) The net realizable value less a normal profit margin should be used to value the inventories because market should not be less than net realizable value less a normal profit margin. To carry the inventories at net realizable value less a normal profit margin provides a means of measuring residual usefulness of an inventory expenditure.

c)

Olson’s beginning inventories at cost and at retail would be included in the calculation of the cost ratio.Net markdowns would be excluded from the calculation of the cost ratio. This procedure reduces the cost ratio because there is a larger denominator for the cost ratio calculation. Thus, the concept of balance sheet conservatism is being followed and a lower-of-cost-or-market valuation is approximated.