Question

At the end of 20X4, Sherpa Lighting Ltd. has a large stock of incandescent lighting fixtures that are becoming obsolete due to a new trend to low energy fluorescent and LED lighting fixtures. The current inventory of incandescent fixtures has a cost of $170,000. The sales manager of Sherpa estimates that the inventory can be sold through the normal course of business over the next several reporting quarters for approximately $150,000. Sales personnel are given a 10% commission on sales. In addition, Sherpa will grant an additional 5% sales commission for sales of these almost obsolete fixtures, intended to make up for the reduced sales prices as well as an additional incentive to sell them.

In early 20X5, Sherpa’s production manager decided that the fixtures can be adapted to not only accept the new LED lighting but also compete quite effectively with new products coming on the market. During 2005, the fixtures are converted at a cost of $25,000. The sales manager estimates that after the conversion, the newly adapted inventory can be repriced to fetch $185,000 (before 10% sales commission) in the market.

Required:

Using the valuation allowance method, prepare the appropriate journal entries to record inventory adjustments at the end of each of 20X4 and 20X5.

Answer 1

20X4

 

NRV: $150,000 × (1.00 – 0.10 – 0.05) = $150,000 × 85% = $127,500

Cost – NRV: $170,000 – $127,500 = $42,500 writedown at the end of 20X4

 

            Holding loss on inventory (COS)......................................             42,500

                     Allowance to reduce inventory to NRV..................                             42,500

 

20X5

 

Cost (without writedown): $170,000 + $25,000 = $195,000

NRV: $195,000 × 90% = $175,500

 

Allowance required at the end of 20X5: $195,000 – $175,500 = $19,500

Adjustment from 20X4 allowance balance to 20X5 balance: $42,500 – $19,500 = $23,000 reversal of writedown

 

            Allowance to reduce inventory to NRV...........................             23,000

                     Reversal of holding loss on inventory (COS)..........                           23,000