Question

At the end of 20X5, Singh Inc. has four inventory items, two of which management believes should be written down. The cost and estimated NRVs of the items are as follows:

 

Required:

1. Determine the amount by which the inventory should be written down if lower of cost or NRV valuation is applied item by item. Prepare the journal entry to record the writedown.

2. Items A and B are related, while Items C and D are related. Determine the inventory writedown if lower of cost or NRV valuation is applied by category. Prepare the journal entry to establish an inventory allowance.

3. Suppose that in 20X6, the NRV of Item A rises to $180 by the end of the year. Prepare journal entries to record the recovery in value, if feasible, under each of the two methods.

4. Explain the advantages and disadvantages of using an allowance instead of direct write down.

Answer 1

Calculations:

Item	#	Cost	NRV	Individual NRV	Individual writedown	Group NRV	Group writedown
A	100	$ 17,000	$ 16,000	$ 16,000	$ 1,000
B	260	20,800	23,400	20,800	x
A + B		$37,800	$ 39,400			$37,800	nil
C	150	21,000	15,000	15,000	6,000
D	200	20,000	24,000	20,000	x
C + D		$41,000	$39,000			$39,000	$ 2,000
Total		$78,800		$71,800	$ 7,000	$76,800	$ 2,000

 

Requirement 1

 

Item-by-item, the writedown would be $7,000:

            Holding loss (COS)...........................................................               7,000

                     Inventory..................................................................                                 7,000

 

Requirement 2

 

Treating the four items as two classes, the write down would be:

    $78,800 – $76,800 = $2,000

            Holding loss (COS)...........................................................               2,000

                     Allowance to reduce inventory to NRV..................                                 2,000

 

Note to instructors; If the writedown is by class, an allowance must be used. Either an allowance or inventory is acceptable as a credit in requirement 1.

Requirement 3

 

a. 

With an individual writedown, the recovery for Item A can be reversed, but only to the extent of the original writedown:

            Inventory...........................................................................               1,000

                     Recovery of holding loss (COS)..............................                                 1,000

 

b.   

When inventory is grouped by class, no recovery is recorded because none of the writedown (of $2,000) pertains to class A+B.

 

Requirement 4

 

The advantage of using an allowance is that the individual subsidiary inventory records do not need to be adjusted for the writedown (nor for any subsequent recovery in value). The allowance method is essential when NRV is performed by inventory class rather than item-by-item, because there would be no way to make the detailed inventory records conform to the general ledger control account.