Question

The Council of the Blind Store has ending inventory with a historical cost of $630,000. Assume the store uses the perpetual inventory system. The current replacement cost of the inventory is $608,000. The net realizable value is $650,000. Before any adjustments at the end of the period, the cost of goods sold account has a balance of $900,000. What journal entry is required under U.S. GAAP?

Answer 1

Under U.S. GAAP, the Council of the Blind Store must report inventory at the lower of cost or market. Therefore, they need to adjust their inventory value from the historical cost of $630,000 to the market value of $608,000, resulting in a $22,000 debit to a Loss account and a credit to Inventory.

Step-by-step explanation:

The student has asked about the journal entry required under U.S. GAAP given the following conditions: an ending inventory with a historical cost of $630,000, a current replacement cost of $608,000, and a net realizable value of $650,000. Under U.S. GAAP, inventory should be reported at the lower of cost or market (LCM), where market is defined as current replacement cost not to exceed net realizable value or to be less than net realizable value minus a normal profit margin. Since the current replacement cost ($608,000) is lower than the historical cost ($630,000), and within the limit set by net realizable value, an adjustment is necessary.

The required journal entry to adjust the ending inventory to its market value would be as follows:

• Debit the Loss Due to Decline of Inventory to Market account for $22,000.
• Credit the Inventory account for $22,000.

This entry reduces the value of the inventory on the balance sheet and recognizes the loss in value in the income statement. No entry is required to adjust the cost of goods sold as the perpetual inventory system continually updates this account.