Question

Alomar Ltd. has been suffering the effects of strong price competition on a particular inventory item from an overseas company that has moved into Alomar’s Canadian market. At the end of 20X4, Alomar management decided that the carrying cost (at historical value) of its year end inventory was not recoverable and that Alomar would have to reduce its prices drastically to meet the competitor’s prices. Management estimated that inventory currently carried at $40,000 (at historical cost) will have a NRV of only $32,000. Alomar normally
priced its products at 50% above historical cost. 

Early in 20X5, Alomar’s competitor unexpectedly withdrew from the Canadian market because of financial difficulties in its home country. Consequently, Alomar restored the prices of its goods to full premarkdown selling price. By the end of 20X5, 60% of the inventory had been sold.

 

Required:

1. Prepare the journal entry for 31 December 20X4 to write down the inventory to NRV. Use the direct writedown method.

2. Prepare a summary journal entry to record the sale of the goods (and the cost of sales) in 20X5 and the writeup of remaining inventory.

3. Suppose that Alomar ’s net income (after the writedown) was $100,000 in 20X4 and $120,000 in 20X5. What would each year’s net income have been if Alomar had not written down the inventory?

Answer 1

Requirement 1

 

            Holding loss on inventory (COS) .....................................               8,000

                     Inventory..................................................................                                 8,000

 

Requirement 2

 

            Accounts receivable ($40,000 × 150% × 60% sold).........             36,000

                     Sales.........................................................................                               36,000

 

            Cost of goods sold ($32,000 × 60% sold)........................             19,200

                     Inventory..................................................................                               19,200

 

            Inventory (40% × $8,000 original writedown).................               3,200

                     Recovery of holding loss (COS)..............................                                 3,200

 

Requirement 3

 

The writedown had the effect of reducing earnings by $8,000 in 20X4. In 20X5, earnings was increased by $4,800 through the sale of 60% of the written-down inventory. Earnings increased again in 20X5 by the write-up of the $3,200 for year-end inventory. The effect was to transfer all of amount of the writedown from 20X4 to 20X5, based on the best estimates at the time. Therefore, 20X5 earnings increased by $8,000, the full amount of the 20X4 writedown. 

 

Without the writedown, 20X4 earnings would have been $108,000 while 20X5 earnings would have been $112,000.

Without the writedown, 20X4 earnings would have been $108,000 while 20X5 earnings would have been $112,000.