L Co. has not been very profitable for the past three years. Additionally, a rec
ID: 350594 • Letter: L
Question
L Co. has not been very profitable for the past three years. Additionally, a recently-ousted manager purchased a substantial quantity of inventory earlier this year…inventory whose customer desirability has waned to some extent. As such, the inventory value has declined 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.)
c. What other information might be useful in making the decision as to how the loss will be recognized on the income statement? (2 pts.)
d. What method would you choose and why? (1 pt.)
Explanation / Answer
The ethical accounting issue faced by L.Co. is whether they should disclose the loss of inventory write-down of $3000000 as a separate entity or to include it as a sub-entry in cost of goods sold. Inventory recording at the market is done by either of the two methods – the cost-of-goods-sold method or the loss method. Cost-of-goods-sold method Substitutes the market value figure for cost Loss gets included in COGS and no individual loss accounting is done Loss method Entry is made debiting the loss and crediting allowance account for the difference of value between cost and market Generally this method is preferred as the sanctity of cost of goods sold account is maintained To make the decision as to how the loss will be recognized and recorded on the income statement, following must be analyzed: The impact of the loss on business The impact of the loss on other costs like cogs, inventory cost, etc. In this case, the loss method will be more appropriate as using the loss method, the accounting details are represented more appropriately. The sanctity of cost of goods sold is maintained and this data then can be used for further analysis.
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