 # Inventory write down

Please explain: Barber Inc. sells DVD recorders. On October 14, it purchased a large number of recorders at a cost of \$90 each. Due to an oversupply of recorders remaining in the marketplace due to lower than anticipated demand during the Christmas season, the selling price at December 31 is \$80 and the replacement cost is \$73. The normal profit margin is 5 percent of the selling price and the selling costs are \$2 per recorder. What should Barber value the recorders at on December 31? A) \$73. B) \$78. C) \$74. D) \$80.

Relevant market value = \$73 Net realizeable value = market price - selling cost = \$80 - \$2 = \$78 floor = Net realizeable value - normal profit = \$78 - (\$80 * 0.05) = \$74 Cieling = Net realizeable value = \$78 So, they should be valued at \$74. Is the answer C?

C NRV range is 74 to 78. Since replacement cost is 73 (which is less than the lower limit) --> inventory should me marked to \$74 If replacement cost was say, >78 then answer would be 78

Could it be valued, under any senario, at any price above \$74 and less than \$78, like \$76?

if that is the case, replacement cost i.e., \$76 will be the answer

Thanks guys, that is the right answer. Can you please explain the rule for this.- ceiling, floor etc that you are talking. many thanks S

1. take the lower of cost (\$90) or market (step 2) 2. you first want to calculate the range for the market values. the upper bound is net realizable value. the lower bound is net realizable value minus a normal profit margin. 3. the value we take depends on the replacement cost (73 in the problem) if the replacement cost is larger than the upper bound, you take the upper bound. if replacement cost is smaller than the lower bound, you take the lower bound. Thus, in this case, we are going to take 74, the lower bound, since the replacement cost of 73 is smaller than the lower bound.

Right, thunderanalyst. But there is an IAS GAAP treatment which I haven’t looked at, should we nail that down too?

vbcfa Wrote: ------------------------------------------------------- > 1. take the lower of cost (\$90) or market (step > 2) > 2. you first want to calculate the range for the > market values. the upper bound is net realizable > value. the lower bound is net realizable value > minus a normal profit margin. > 3. the value we take depends on the replacement > cost (73 in the problem) if the replacement cost > is larger than the upper bound, you take the upper > bound. if replacement cost is smaller than the > lower bound, you take the lower bound. > > Thus, in this case, we are going to take 74, the > lower bound, since the replacement cost of 73 is > smaller than the lower bound. Thanks vbcfa So, essentially it means: 1. Decide between historical cost and market. 2. If it is market then take the median of replacement cost, NRV and NRV-Profit margin. Is my interpretation correct? S

if it is market, you choose the high or low value in the range - no median is involved

Can some body explain- what cost means and what market means in the context of LCM? Thanks S

Cost is what the manufacturer incurs if it were to manufacture it today (not yesterday). Market price is what it is selling for in the market today (not yesterday).

Dreary, Can you explain further. So cost is 73 in this case and market ranges from 74 to 78. So if it lower of cost or market, why 73 is not right? I am sorry I am not able to understand it completely, please bear with me. Thanks S

Under U.S. GAAP, market value is defined as current market price with NRV as ceiling and (NRV minus normal profit) as floor, that’s a rule you have to follow. 1. Currently you are recording them at \$90 a piece. 2. They are selling in the market for only \$80 a piece, so your inventory is overstated. 3. They can be replaced for \$73 a piece, so may be you should record them at \$73, right? Yes, but. 4. If you sell them for \$80, and you deduct selling cost of \$2, you get what’s called a Net realizeable value (NRV) = \$78, that’s the maximum you should record them at. But that still makes your inventory overstated because teh rule says this is the max. 5. So, you estimate that you are entitled to make a profit of 5% (\$80 *0.05= \$4). 6. In that case, you realize that the minimum value to record them at is \$78-\$4 = \$74.

nice common-sense explanation…you did a much better job of it than schweser anyway!

Dreary Wrote: ------------------------------------------------------- > Under U.S. GAAP, market value is defined as > current market price with NRV as ceiling and (NRV > minus normal profit) as floor, that’s a rule you > have to follow. > > 1. Currently you are recording them at \$90 a > piece. > 2. They are selling in the market for only \$80 a > piece, so your inventory is overstated. > 3. They can be replaced for \$73 a piece, so may be > you should record them at \$73, right? Yes, but. > 4. If you sell them for \$80, and you deduct > selling cost of \$2, you get what’s called a Net > realizeable value (NRV) = \$78, that’s the maximum > you should record them at. But that still makes > your inventory overstated because teh rule says > this is the max. > 5. So, you estimate that you are entitled to make > a profit of 5% (\$80 *0.05= \$4). > > 6. In that case, you realize that the minimum > value to record them at is \$78-\$4 = \$74. That explanation is simply phenomenal!!!

Two questions: 1. why do you subtract the profit margin of \$4 from the NRV of \$78, to get the lower bound of \$74? 2. What if the amount calculated by subtracting the profit margin from the NRV was below \$73? Does the replacement cost ever become the lower bound?

So you have to record them at the lowest of either: (1) cost, which is \$90, or (2) market price. But market price is required to be between two values: 1. Upper value, which is the Net Realizable Value=\$78, and 2. Lower bound, which is defined to be the upper bound minus your normal profit, \$74. This is so because apparently you should not record your inventory at less than what it is worth to you when you do a writedown like this. I don’t know the exact reason. To your second question, if the lower bound was \$70, then you will choose \$73, since it will be within the bounds. That’s the idea of having this range. Question: Could it be recorded at \$78 at all?