Question

Springer Anderson Gymnastics prepared its annual financial statements dated December 31. The company reported its inventory using the LIFO inventory costing method but did not compare the cost of its ending inventory to its market value (replacement cost). The preliminary income statement follows:

Sales Revenue					$	140,000
Cost of Goods Sold
Beginning Inventory	$	15,000
Purchases		91,000
Goods Available for Sale		106,000
Ending Inventory		22,000
Cost of Goods Sold						84,000
Gross Profit						56,000
Operating Expenses						31,000
Income from Operations						25,000
Income Tax Expense (30%)						7,500
Net Income					$	17,500

Assume that you have been asked to restate the financial statements to incorporate the LCM/NRV rule. You have developed the following data relating to the ending inventory:

				Purchase Cost
Item	Quantity			Per Unit				Total				Replacement Cost per Unit
A		1,500		$	3			$	4,500			$	4
B		750			4				3,000				2
C		3,500			2				7,000				1
D		1,500			5				7,500				3
								$	22,000

Required:

1. Restate the income statement to reflect LCM/NRV valuation of the ending inventory. Apply LCM/NRV on an item-by-item basis.
2. Compare the LCM/NRV effect on each amount that was changed in the preliminary income statement in requirement 1.

Answer 1

1.

	Amount ($)	amount ($)
Sales revenue		140,000
(-) cost of goods sold :
Beginning inventory	15000
Purchases	91000
Goods available for sale	106000
Ending inventory	14000 [refer note 1]
Cost of goods sold		(92000) [refer note 2]
Gross profit		48000
(-) operaring expenses		(31000)
Income from operations		17000
(-) income tax		(5100) [17000×30%]
Net income		11900

Note 1:

		Purchase cost		replacement cost		LCM/NRV
Item	qty	per unit ($)	total ($)	per unit ($)	total ($)	Total ($)
A	1500	3	4500	4	6000	4500
B	750	4	3000	2	1500	1500
C	3500	2	7000	1	3500	3500
D	1500	5	7500	3	4500	4500
			22000		15500	14000

Note 2:

Cost of goods sold = opening inventory + purchases - closing inventory.

= $15000 + $91000 - $14000

= $106000 - $14000

= $92000

2. Statement showing effect of LCM/NRV on items of preliminary income statement :

	1 Preliminary figures ($)		2 After LCM/NRV effect ($)		3 Increase/(decrease)
					Increase/(decrease) in amount	increase/(decrease) in percentage	Favorable /unfavorable
Sales		140,000		140,000	No effect
(-) cost of goods sold :
Beginning inventory	15000		15000		No effect
Purchase	91000		91000		No effect
Goods available for sale	106000		106000		No effect
Ending inventory	22000		14000		(8000)	(36.36%)
Cost of goods sold		(84000)		(92000)	8000	9.52%	unfavorable (as cost increased)
Gross profit		56000		48000	(8000)	14.28%	unfavorable ( as profit reduced)
(-) operating expenses		(31000)		(31000)	No effect
Income from operations		25000		17000	(8000)	(32%)	unfavorable (as income reduced)
Income tax		(7500)		(5100)	(2400)	(32%)	favorable (as tax burden reduced)
Net income		17500		11900	(5600)	(32%)	unfavorable (as income reduced)

Note 3: in the first and second column, () indicates subtraction. In the third column () indicates decrease.

Overall effect is that cost of goods sold increased, as a result net income decreased.