The text is talking about the valuation of lower of cost or market (net realizab

Question

The text is talking about the valuation of lower of cost or market (net realizable value).

It provides an example of "Intel chips" in being devalued in the following way:

Intel Chips - [Qty] 1,000 [Cost per Item] $250 [Market Per Item] $200 [Lower of Cost or Market per item] $200 Total Lower of Cost or Market 1,000 x $200 = $200,000

This part makes sense. The text then indicates that the following effects of the lower of cost or market write-down (of the $50,000 dollars) are as follows:

Question: I am seeking an explanation as to why does the COGS and Pre-tax income change in opposition in the next period from the current period.

Please help with an explanation so that I may understand.

Effects of LCM Write Down Current Period Next Period (if sold) Costs of Goods Sold Increase $50,000 Decrease $50,000 Pretax Income Decrease $50,000 Increase $50,000 Ending Inventory on balance sheet Decrease $50,000 Unaffected

Explanation / Answer

It is the ending stock to which the LCM is applied, as a result of which the ending stock will be stated at a lesser figure than the actual cost. The corollary of this is that, the COGS will be higher and pretax income will be lower. Please note that COGS = Beginning inventory+Purchases-Ending inventory. Lower ending inventory value will push up COGS.

The next year, the previous year'sending inventory (stated at a lower value) will become the beginning inventory. The effect of this (as per the above equation) will be opposite in nature.

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