Question

Which of the following is the effect of using lower of cost or market on the liquidity metric? a.An increase in net income b.An increase in the days' sales in inventory c.A decrease in sales d.A decrease in the days' sales in inventory

Answer 1

Lower of cost or market is applied when the total value of closing inventory could not be realized by converting them into sales. This is because , the closing inventory usually have historical cost , that the cost of invenventory during its purchase. But the market is always bound to fluctuation with passage of time. One of the portant fluctuation in market is the value of a product at present time or its present value. For example, imagine an inventory was purchased for $10, assuming that it could be sold at market at the price of $12. That is a profit of $2, was expected with each unit. But as goods cannot be sold instantly, there would be a time lapse between purchase and sale of any goods with an anticipated gain. During these time lapse, there is a chance that the value of inventory expected to be sold drops to $9 from $12 , which was its market value during purchase of that particular inventory. But the value of goods had dropped from its historical value. This is an indication of $3 per unit ad per the above details. The is when the lower of cost or market method is applied. This method is used to report loss , by charging the loss due to present value of a product at market as cost of goods sold. In the above example, the loss reported ad C.O.G.S will be $3per unit .Considering all these, the appropriate option for correct answer will be option 'c'. The sales day in inventory is the time lapse between procurement and sales, for example only, of a product. It has nothing to do with decrease in sales which indicates a loss directly. Though sales day in may become a cause for loss of a product, it cannot be the affect, as the affect of reporting a loss equals decrease in sales. So these two options pertaining sales day in inventory is inappropriate. Loss can never lead to increase in income , so certainly option 'a' is inappropriate.