University of Phoenix
Client Understanding Paper
As per your request of an analysis of the following topics: Adjusting lower of cost or market inventory on valuation, Capitalizing interest on building construction, Recording gain or loss on asset disposal, and Adjusting goodwill for impairment. The Financial Accounting Standards Board (FASB) established clear guidelines addressing the items mentioned above. I will outline that FASB generally accepted accounting standards (GAAP) affect each area, and how these improvements to the company will benefit the company’s financial health (FASB, 2010).
The methods of inventory valuation are different according to companies, but at the end of the day the chosen method should be consistent each year according to the general accepted accounting principles. A manufacturing company will generate inventories for finished product, raw materials and work in progress, so lowering the cost of market inventory can be very intimidating and consuming. Inventories and prepaid expenses present some additional valuation issues. With the emphasis on net income reporting, the inventory valuation process has become secondary to the matching of expired inventory costs to sales. The use of any of the acceptable inventory flow assumption techniques prescribes the amount that remains on the balance sheet, and it is likely that each of these flow assumptions will result in different inventory valuations in fluctuating market conditions. In addition, the accounting convention of conservatism requires that a lower of cost or market valuation be used for inventories (Schroeder, Clark, & Cathey, 2005).
Using the first-in-first out (FIFO) or the last-in-first-out (LIFO) method is the perfect way to identify the cost of each inventory item. “A valuation method (e.g. LIFO, FIFO, average cost and specific identification) is used to compute the cost of the inventory dollar amounts and then it is compared to the market dollar amount.” LIFO is not commonly used because the last goods purchased are the first to be sold. The inventory at the beginning of the year will have the earliest goods purchased acquiring a valuation of an early price. FIFO is better used for lowering cost especially during periods of increase prices. It is also important to identify a method for valuing the items in the inventory and calculating the cost of goods sold. This can be done through the cost method, the lower of cost or market and the retail method. “A valuation method is used to compute the cost of the inventory dollar amounts and then it is compared to the market dollar amount. The lower of the two amounts must be used when recording inventory.” The cost method involves all direct and indirect costs to acquire the inventory. The cost of the products purchased consists of the invoiced purchase price minus discounts or trade with and addition of transportation, shipping additional cost incurred for attaining the product. Lower of cost or market method “determine the market value of each item on hand as of the inventory date, compare the market value with the cost of each item, and use the lower of the two as the inventory value of that item” (Hagen, 2005).
The American Institute of Certified Public Accountants (AIPCA) in conjunction with the Financial Standards Accounting Board (FASB) issued ARB No. 43 that lower of cost or market rule apply to all inventories. Lower of cost or market aspect (LCM) is also supported and defined by SFAC No. two and SFAC No. 6. The LCM rule considers the market that purchases and sells the inventory. In general, the conservatism principle applies to LCM method of accounting. Conservatism principle directs a company to choose the more “conservative” dollar amount when considering two amounts that represent inventories. This helps a Company to report accurate losses on their income statement. To determine LCM, one must also consider net realizable value (NRV). This...
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