Client Understanding Paper

Topics: Generally Accepted Accounting Principles, Balance sheet, Inventory Pages: 6 (1677 words) Published: August 21, 2010
Client Understanding Paper
Accounting Issue:
When and why to adjust inventory values to lower of cost or market? Sources:
35-1 A departure from the cost basis of pricing the inventory is required when the utility of the goods is no longer as great as their cost. Where there is evidence that the utility of goods, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the difference shall be recognized as a loss of the current period. This is generally accomplished by stating such goods at a lower level commonly designated as market. 330-10-35-2

35-2 The cost basis of recording inventory ordinarily achieves the objective of a proper matching of costs and revenues. However, under certain circumstances cost may not be the amount properly chargeable against the revenues of future periods. A departure from cost is required in these circumstances because cost is satisfactory only if the utility of the goods has not diminished since their acquisition; a loss of utility shall be reflected as a charge against the revenues of the period in which it occurs. Thus, in accounting for inventories, a loss shall be recognized whenever the utility of goods is impaired by damage, deterioration, obsolescence, changes in price levels, or other causes. The measurement of such losses shall be accomplished by applying the rule of pricing inventories at the lower of cost or market. This provides a practical means of measuring utility and thereby determining the amount of the loss to be recognized and accounted for in the current period. 330-10-35-3

35-3 The rule of lower of cost or market is intended to provide a means of measuring the residual usefulness of an inventory expenditure. The term market is therefore to be interpreted as indicating utility on the inventory date and may be thought of in terms of the equivalent expenditure which would have to be made in the ordinary course at that date to procure corresponding utility. 330-10-35-4

35-4 As a general guide, utility is indicated primarily by the current cost of replacement of the goods as they would be obtained by purchase or reproduction. In applying the rule, however, judgment must always be exercised and no loss shall be recognized unless the evidence indicates clearly that a loss has been sustained. There are therefore exceptions to such a standard. Replacement or reproduction prices would not be appropriate as a measure of utility when the estimated sales value, reduced by the costs of completion and disposal, is lower, in which case the realizable value so determined more appropriately measures utility. Apply to Guidance:

When the selling price of the inventory is below the cost, inventory cost needs to be re-evaluated. Some of the causes of this could be physical damage to the inventory, obsolescence, changes in supplier pricing levels, etc. When this occurs, the company must recognize the loss in the current period, even if the inventory has not been sold and is still on the books. This is accomplished by determining the market value of the inventory. In this context, the term market is the cost of replacement inventory under current market conditions as of the date of inventory valuation. The loss that is recognized in the current period is the difference between the current book value of the inventory and the current replacement cost (market) value. This amount is then booked as a loss in the period in which the decrease in value occurred. This results in a lower book value for the inventory. When this inventory is sold in a subsequent period, the lower cost of the inventory will more accurately reflect true cost of goods sold in the period in which the sale occurs. Accounting Issue:

Why and when to capitalize interest on building construction? Sources:
10-1 The objectives of capitalizing interest are to obtain a...
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