Question

Rowan Company has four different categories of inventory. The quantity, cost, and market value for each of the inventory categories are as follows: Item Quantity Cost Per Unit Market Value Per Unit 1 220 $ 4.40 $ 4.60 2 130 $ 6.20 $ 6.00 3 100 $ 10.00 $ 9.25 4 25 $ 20.50 $ 25.00 The company carries inventory at lower-of-cost-or-market applied to the entire stock of inventory in the aggregate. How would the implementation of the lower-of-cost-or-market rule impact the elements of the company’s financial statements? Multiple Choice Increase total assets and stockholders’ equity by $55.50. Decrease total assets and stockholders’ equity by $101.00. Decrease total assets and stockholders’ equity by $79.00. Have no effect on total assets or stockholders’ equity.

Answer 1

Answer: Total assets will decrease by $101 and shareholders' equity will decrease by $101

Explanation:

Inventory is initially Valued at Historical costs, Situations or conditions may change in the market which may affect the value of inventory on hand. When The cost of inventory is above the market price it is an indication that Inventory has lost its value and as a result the value of inventory must be adjusted.

The Lower of Cost or Market value method is a method of valuing inventory which stipulates that inventory should be value at the lower of cost or current market value. Determining inventory Market Value involves calculating  lower limits, Net realizable value , upper limits. The question provided us with the Market Values therefore we donot need to get into the process of calculating the Market Value.

Using Lower of Cost or Market to Value inventory

Inventory item 1

unit cost = $ 4.40 , Market value per unit = $4.60

Use cost per unit, cost per unit is lower than Market Value per unit. Inventory Value = 220 units x $4.40 = $968

Inventory item 2

unit cost = $ 6.20 , Market value per unit = $6

Use Market Value per unit, Market Value per unit is lower than  cost per unit. Inventory Value = 130 units x $6 = $780.

Decrease inventory by = (6.20 - 6) x 130 = $26

Inventory item 3

unit cost = $ 10 , Market value per unit = $9.25

Use Market Value per unit, Market Value per unit is lower than cost per unit. Inventory Value = 100 units x $9.25 $925.

Decrease inventory by = (10 - 9.25) x 100 = $75

Inventory item 4

unit cost = $ 20.50 , Market value per unit = 25

Use cost per unit, cost per unit is lower than Market Value per unit. Inventory Value = 25 units x $20.50 = $512.50

When The lower of cost or Market value rule is implemented, inventory will be written down by a total amount of $101 ($75 + $26). Total assets will decrease by $101 and shareholders' equity will decrease by $101 because  inventory write downs losses decrease profits which will effectively affects Shareholders' equity

Answer 2

Answer:

The correct answer is that the valuation would decrease total assets and stockholders’ equity by $101.00

Explanation:

Item             Cost                      Market price            Impact

Quantity

1 220 $ 4.40  $ 4.60        no impact as cost is lower

2 130 $ 6.20  $ 6.00 ($6.20-$6.00)* 130=$26

3 100 $ 10.00  $ 9.25 ($10-$9.25)*100    =$75

4 25 $ 20.50  $ 25.00 No impact as cost is lower

The total reduction in the value of inventory as a result of adopting the lower of cost or market price valuation is $101 ($75+$26),hence decreases total assets by $101 and the stockholders' equity(retained earnings which is a component of stockholders' equity ) by the same amount