BOZ Co. has determined its year-end inventory on a FIFO basis to be $500,000. In
ID: 2415529 • Letter: B
Question
BOZ Co. has determined its year-end inventory on a FIFO basis to be $500,000. Information pertaining to that inventory follows:
Estimated selling price
$508,000
Estimated cost of disposal
20,000
Normal profit margin
60,000
Current replacement cost
455,000
BOZ records losses that result from applying the lower-of-cost-or-market (LCM) rule. At its year-end, what should be the net carrying value of BOZ’s inventory?
$500,000
$488,000
$455,000
None of the above is correct
Estimated selling price
$508,000
Estimated cost of disposal
20,000
Normal profit margin
60,000
Current replacement cost
455,000
Explanation / Answer
When replacement cost was given the carrying cost will be calculated as follows:
Lower of cost or market (LCM) : LCM is the lower of cost or replacement cost, with the replacement cost being no higher than NRV( Celing)and no lower than NRV minus the normal profit(Floor).
Net realizable value( Celing)is the expected selling price in the ordinary course of business minus the cost to complete and dispose. NRV will be the upper limit (the ceiling) for the replacement cost.
Cost = $5,00,000
Selling price = $5,08,000
Cost of disposal = $ 20,000
Profit margin = $ 60,000
Current replacement cost = $ 4,55,000
Net realizable value (NRV) ceiling (Upper limit)= Expected selling price -Cost of disposal
= $ 5,08,000 -$ 20,000
= $ 4,88,000
Net realizable value- profit (Floor)( Lower limit) = $ 4,88,000- $60,000
= $ 4,28,000
Market value: from the following
1. the upper limit, or ceiling, for the replacement cost = $ 4,88,000
2. replacement cost = $ 4,55,000
3. the lower limit, or floor, for the replacement cost =$4,28,000
Hence Market value = $ 4,55,000 (The Replacement cost is between $ 4,28,000 and Ceeling $ 4,88,000) hence replacement cost will be used as market value.
Hence carrying cost = cost ($5,00,000) or Market value ( $ 4,55,000) which ever is low
= $ 4,55,000
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