question archive Canton Trade Mart has recently had lackluster sales
Canton Trade Mart has recently had lackluster sales
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Canton Trade Mart has recently had lackluster sales. The rate of inventory turnover has dropped, and the merchandise is gathering dust. At the same time, competition has forced Canton’s suppliers to lower the prices that Canton will pay when it replaces its inventory. It is now December 31, 2014, and the current replacement cost of Canton’s ending inventory
is $7,000 below what Canton actually paid for the goods, which was $98,000. Before any adjustments at the end of the period, the Cost of Goods Sold account has a balance of $410,000.
a. What accounting action should Canton take in this situation?
b. Give any journal entry required.
c. At what amount should Canton report Inventory on the balance sheet?
d. At what amount should the company report Cost of Goods Sold on the income statement?
e. Discuss the accounting principle or concept that is most relevant to this situation.
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a. Canton Trade Mart should apply the lower-of-cost-or-market rule to account for inventories. The current replacement cost of ending inventory is less than Canton's actual cost, so Canton must write the inventory down to current replacement cost, with the following journal entry:
b.
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Cost of Goods Sold.............................................. |
7,000 |
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Inventory...................................................... |
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7,000 |
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To write inventory down to market value. |
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Canton Trade Mart should report the following amounts in its financial statements:
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c. BALANCE SHEET |
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Inventory at market (which is lower than |
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cost of $98,000).................................................................................. |
$91,000* |
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d. |
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INCOME STATEMENT |
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Cost of goods sold ($410,000 + $7,000)................................................. |
$417,000 |
_____
*$98,000 − $7,000 = $91,000
e. Relevance and Representational faithfulness are the reasons to account for inventory at the lower of cost or market value. Representational faithfulness directs accountants to report inventory at the most realistic and transparent amount. In this case the current replacement cost (market value) of Canton Trade Mart's ending inventory is less than cost, and the lower-of-cost-or-market rule requires a write-down of the inventory value to current replacement cost.
