Question

A construction company owns raw materials inventory that total $408,000 (detail listed below) in the general ledger and has an allowance to reduce inventory to net realizable value (NRV) in the amount of $27,500 (a credit balance) in the general ledger at May 31, 2020, the end of the company’s fiscal year.

1. Using the data below, prepare a detailed schedule to determine the proper balance in the allowance to reduce inventory to NRV account at May 31, 2020.

2. Using the attached T-account template, (1) document the balance in the inventory and allowance accounts and (2) prepare the journal entries required, assuming the company uses a perpetual inventory system and the “cost of goods sold” method to adjust to the lower of cost or net realizable value.

3. Explain the rationale for the use of LCNRV rule as it applies to inventories.

Data:

	Cost	Sales Price	NRV
Raw Material #1	70,000	64,000	56,000
Raw Material #2	86,000	94,000	84,800
Raw Material #3	112,000	186,400	168,300
Raw Material #4	140,000	154,800	140,000
Total	408,000	499,200	449,100

Analysis:

Answer 1

A)
B)

Date: Page: I Calmlahn bulance in of - Proper Cost allowance Account Cost or Amout to -NRW, Whithere's be charged to allowance Particulars NRV Tower S ale Raw Material. I to,000 56.000 56, ovoli 14,000 C70,000-soon) Raw Matorial 2 86,000 84,80 84,80 1,200 (86000 845w) Row Material 3 1 12,000 1,08,300 1,12,000 - - Paw 1,40,000 1,40,00 Material 4 1,40,000 WE WILL --- Sires o permy belanu_of Allowme ilke (27,50) - Closing belonce 18,300 ---------- Note: As the net rchasuble to all the Cost ar met - Lower Inventory is valued at value, whicheve is lover, raw material are valued recliruble value, whichena cost or so at as ---

(0) Amewat. Parchalas. Amount Parbular To Raw Material 1 To Raw Material 2 To, Raw Material 3 To Raw material 4 14,000 er | 70, ovo By, Allowance de RM-) 186, ovo By Allowone al CRM 42,000 14,ono By Butre elf -_- 13,42,800 14,08, on 4,03, ovo A/C Particulars -Allowance Amount Particulars | Amount By, Balance bld 17,500 To, DM-L Tog RM-2 To, balance of 14.000 1,200 12 300 27, roo IP7, Sool

Date : Page : 12 Journal Partitudina entrics Debit - credit 4.00 _.14a Allowance - To (Being bronin Ale Inventory amount NRV Dr. ale charged for Row for Material - 1) to مهر yen Allowance ale Dr. - Tor Inventory ale ( Being amount charged to NRV for Raw for brining Material may

C)

Although every attempt is made to prepare and present financial data that are free from bias, accountants do employ a degree of conservatism. Conservatism dictates that accountants avoid overstatement of assets and income. Conversely, liabilities would tend to be presented at higher amounts in the face of uncertainty. This is not a hardened rule, just a general principle of measurement.

In the case of inventory, a company may find itself holding inventory that has an uncertain future; meaning the company does not know if or when it will sell. Obsolescence, over supply, defects, major price declines, and similar problems can contribute to uncertainty about the “realization” (conversion to cash) for inventory items. Therefore, accountants evaluate inventory and employ lower of cost or net realizable value considerations. This simply means that if inventory is carried on the accounting records at greater than its net realizable value (NRV), a write-down from the recorded cost to the lower NRV would be made. In essence, the Inventory account would be credited, and a Loss for Decline in NRV would be the offsetting debit. This debit would be reported in the income statement as a charge against (reduction in) income.