Hi all. Hope this is the right section for this. Studying for FAR with Becker (my first exam). I'm working through F4 following the NINJA framework, and came across a question/concept issue with Inventory and LCM. On F4-22, under roman numeral III “Valuation of Inventory,” the text says “Where evidence indicates cost will be recovered with an approximately normal profit on a sale in the ordinary course of business, no loss should be recognized even though replacement or reproduction costs are lower.”… In other words, valued at cost if theres a profit to be had, at LCM if selling at a loss. Simple enough.
Then I get to one of the MCQs in the lecture:
Based on a physical inventory taken on December 31, an entity determined its inventory on a FIFO basis to be $70,000, with a replacement cost of $65,000. The entity estimated that after further processing costs of $8,000, the completed inventory could be sold for $75,000. The entity's normal profit margin is 30%. What amount should the entity report as inventory in its December 31 balance sheet under U.S. GAAP?
I chose $70,000 as the answer, with the thinking of $75,000 (selling price) > $70,000 cost basis = gain to be had = no need to revalue. The correct answer is apparently $65,000, the lower of cost or market:
“Choice “b” is correct. Under U.S. GAAP, inventory is reported at the lower of cost or market. Under lower of cost or market, market is the middle value of replacement cost, the market ceiling (net realizable value), and the market floor (NRV – normal profit):
Ceiling, net realizable value ($75,000 – 8,000)
$67,000
Replacement cost
65,000
Floor, NRV less profit [$67,000 – (30% of $75,000)]
44,500″
I understand the calculation, etc. I just still don't why the inventory had to be revalued in the first place, if the cost was 7-70,000 and the SP was 75,000. I'm guessing it has something to do with the 8,000 costs to sell in the NRV calculation, but I was under the impression its the actual selling price that matters.
Any clarification would be fantastic!
.