Question

Financial accounting

19) In an annual report, Craftmade International, Inc., describes its inventory accounting policies as follows:

Inventories are stated at the lower-of-cost-or-net-realizable value, with inventory cost determined using the first-in, first-out (FIFO) method. The cost of inventory includes freight-in and duties on imported goods.

Also in an annual report, Kaiser Aluminum Corporation made the following statement in discussing its inventories:

The company recorded pretax charges of approximately $19.4 million because of a reduction in the carrying values of its inventories caused principally by prevailing lower prices for alumina, primary aluminum, and fabricated products.

What accounting principle did Craftmade International follow when it included the costs of freight-in and duties on imported goods in its Inventory account? Briefly describe how a firm determines which costs to include in its inventory account. What accounting principle did Kaiser Aluminum follow when it recorded the $19.4 million pretax charge? Briefly describe the rationale for this principle.

Answer 1

For valuation of inventory, the cost of material, freight thereon and taxes & duties is considered. If it assume that inventory is valued at cost only by Craftmade international , it means that the company is following Historical cost concept of accounting. As per Historical cost concept of accounting, inventory should be recorded at their original cost until they are sold. No profit or loss should be recognized.

However as further it has been stated that the company is recorded 19.4 million pretax charge on account of reduction in the carrying values of its inventories caused by prevailing lower prices for alumina, primary aluminum and fabricated products, it means that the company is following prudence concept of accounting which concept prescribes to value the inventory at cost or net realizable value whichever is lower. Net realizable value is sale price of inventory less any future cost to be incurred to put it into saleable condition and less any anticipated selling expenses. The valuation of inventory at lower of cost or net realizable value conforms to matching concept of accounting. Any reduction in the value of inventory is recognized in year in which such loss occurred instead of recognizing in the year of sale.

All kind of cost incurred to make the product ready for sale is included for valuation of inventory like freight, taxes and duties etc.