Ethics Question #2 (10 pts: 7 pts. for content; 3 pts. for communication) | L Co
ID: 2552970 • Letter: E
Question
Ethics Question #2 (10 pts: 7 pts. for content; 3 pts. for communication) | L Co. has not been very profitable for the past three years. Additionally, a recentlynew pusted | customer desirability haswas waned to some extent. As such, the inventory value has declined manager purchased a substantial quantity of inventory earlier this year...inventory whose below its cost and two methods of handling the write-down are being discussed: showing the amount of the write-down ($3,000,000) as a line item loss on the income statement and showing the loss as part of cost of goods sold. Both methods are GAAP a. What is the ethical accounting issue in this situation? (1 pt.) b. Considering the qualitative characteristics of accounting as well as basic accounting concepts, discuss pros and cons of using (1) the loss method and (2) the CGS method. (3 pts.) What other information might be useful in making the decision as to how the loss will be recognized on the income statement? (2 pts.) c. d. What method would you choose and why? (1 pt.)Explanation / Answer
Solution :
a : As per US GAAP, under the lower of cost or market (LCM) rule, inventory should be written down to market subsequent to acquisition if its utility is no longer as great as its cost. The difference should be recognised as a loss of the current period. It is ethical to use the loss method for the current year.
b. Loss Method :
Pro : Immediate recognistion of the loss , showing a seperate item in the income statement shows the clearer picture of the loss
Con : This loss will not affect the gross margin. This loss cannot be charged back to the customer as a product cost because it would be treated as a period cost and witten off in income statement.
CGS method
Pro : Since the loss is written off or is treated as a part of cost of goods sold, it would help the firm in determining a better gross margin. This cost would form a part of inventoryand this can be charged back to the customer.
Cons : The write off is not a normal loss and should not form a part of the cost of goods sold. This would inflate the value of the closing stock which should not be the case.
c. Other information : It is mentioined that the company, is not profitable for the past years . Also indicators that the the market price is below the cost price . Applying the RCM rule under US GAAP, the loss needs to be written of in the income statement.
d. The loss method is the best method since it is not only the best method to present in the income statement but also requires to write off as a period cost.
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