Evaluating the Income Statement and Cash Flow Effects of Lower of Cost or Market Harvey Company prepared its annual financial statements dated December 31, 2011. The company applies the FIFO inventory costing method; however, the company neglected to apply LCM to the ending inventory. The preliminary 2011 income statement follows:
|
Sales revenue |
$280,000 |
|
Cost of goods sold |
|
|
Beginning inventory |
$33,000 |
|
Purchases |
184,000 |
|
Goods available for sale |
217,000 |
|
Ending inventory (FIFO cost) |
46,500 |
|
Cost of goods sold |
170,500 |
|
Gross profit |
109,500 |
|
Operating expenses |
62,000 |
|
Pretax income |
47,500 |
|
Income tax expense (30%) |
14,250 |
|
Net income |
$33,250 |
Assume that you have been asked to restate the 2011 financial statements to incorporate LCM. You have developed the following data relating to the 2011 ending inventory:
|
Acquisition Cost |
Current Replacement Unit Cost |
|||
|
Item |
Quantity |
Unit |
Total |
(Market) |
|
A |
3,050 |
$3 |
$9,150 |
$4 |
|
B |
1,500 |
5 |
7,500 |
3.5 |
|
C |
7,100 |
1.5 |
10,650 |
3.5 |
|
D |
3,200 |
6 |
19,200 |
4 |
|
$46,500 |
||||
Required:
1. Restate this income statement to reflect LCM valuation of the 2011 ending inventory. Apply LCM on an item by item basis and show computations.
2. Compare and explain the LCM effect on each amount that was changed on the income statement in requirement (1).
3. What is the conceptual basis for applying LCM to merchandise inventories?
4. Thought question: What effect did LCM have on the 2011 cash flow? What will be the long term effect on cash flow?