Problem Solving Survival Guide to accompany Financial Accounting, 8th Edition

SOLUTION TO EXERCISE 6-4

1. $340,000 The current replacement cost of $340,000 should be used to value the ending inventory for purposes of reporting the asset on the balance sheet because market (replacement cost) is lower than cost.
2. 
3. The lower of cost of market (LCM) rule is based on the accounting concept of conservatism which dictates that when choosing among accounting alternatives, the best choice is the treatment that is the least likely to overstate assets and net income. Or to state it another way, in matters of doubt and uncertainty, take the conservative approach (the approach that has the least favorable effect on net income and owner's equity).

   The current replacement cost (cost of purchasing the same goods at the present time from the usual suppliers in the usual quantities) is lower than original cost. This indicates the supplier has been lowering prices. The same economic forces that caused the supplier to lower its prices are likely to cause Electronics Galore (EG) to lower its selling prices so that EG will end up selling them at a price lower than cost or at a price that cuts down on the normal gross profit experienced by EG. There has been a loss in the utility (value) of the inventory. The LCM rule provides that the loss should be recognized in the period of the decline in utility rather than be deferred and recognized in the period of sale.

   By reporting a lower ...