BKAR2023 FINANCIAL ACCOUNTING AND REPORTING II (A172)

MINI CASE 2

INVENTORIES

DUE DATE: 14 March 2018 (Wednesday) before 4.00 pm.

QUESTION 1

Melada Bhd determined its ending inventory at cost and at LCNRV at December 31, 2015, December 31,
2016, and December 31, 2017, as shown below.

Costs (RM) LCNRV (RM)

31 Dec 20X5 650,000 650,000
31 Dec 20X6 780,000 712,000
31 Dec 20X7 905,000 830,000

Instructions:

(i) Prepare the journal entries required at December 31, 20X6, and at December 31, 20X7,
assuming that a perpetual inventory system and the cost-of-goods-sold method of adjusting to
LCNRV is used.
(ii) Prepare the journal entries required at December 31, 20X6, and at December 31, 20X7,
assuming that a perpetual inventory system and reduced to LCNRV using the loss method.

Suggested answers

(i) Cost-of-Goods-Sold Method

December 31, 20X6
Cost of Goods Sold.................................................................................................
68,000
Allowance to Reduce Inventory to NRV.................................................... 68,000
   (RM780,000 – RM712,000)

December 31, 2017

Cost of Goods Sold.................................................................................................
7,000
Allowance to Reduce Inventory to NRV

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 [(RM905,000 – RM830,000) – RM68,000]............................................. 7,000

(ii) Loss Method

December 31, 20X6
Loss Due to Decline of Inventory to NRV..............................................................
68,000
Allowance to Reduce Inventory to NRV.................................................... 68,000
   (RM780,000 – RM712,000)

December 31, 20X7

Loss Due to Decline of Inventory to NRV..............................................................
7,000
Allowance to Reduce Inventory to NRV
[(RM905,000 – RM830,000) – RM68,000]............................................. 7,000

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QUESTION 2

MayLove Bhd is a company that specialised in producing office furnishings for industry-
customers as well as for walk-in customers. The furnishings are grouped based on its materials.
The following information is available from the company’s inventory records as at 31 December
2016.

Wooden Bamboo Rattan Metal Glass Acrylic

Furniture Furniture Furniture Furniture Furniture Furniture
(RM) (RM) (RM) (RM) (RM) (RM)
Historical
cost – FIFO 213,500 122,500 178,500 21,500 50,000 25,000
method
(in total)

Estimated
selling price 4,125 4,375 5,125 1,875 2,500 750
(per unit)

Estimated 750 1,750 3,500 1,000 1,250 375

cost to
complete and
sell
(per unit)

Number of 40 32 40 40 56 40
units

Inventories are recorded at their cost. However, due to the market intense competition and
declining in demand for company’s product, the operation of MayLove Bhd has also affected
and its inventory has declined in value. MayLove Bhd has taken an approach to follow the
practice of valuing its inventory at the Lower of Cost or Net Realisable Value (LCNRV) method.
MayLove applies the loss method and uses an Allowance Account to record for the write down
of the inventory to net realisable value.

REQUIRED:
(Round your answers to the nearest RM)

(a) Assuming that MayLove applies the LCNRV rule to each major groups of furniture.
Determine the following items as at 31 December 2016:
(i) Net Realisable Value (NRV) per major group,
(ii) Lower-of-Cost-or-NRV (LCNRV) per major group, and
(iii) The final amount of inventory.

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(b) Prepare the journal entry at 31 December 2016 to account for the write-down of the
inventory to NRV. Assuming the use of a perpetual inventory system.

(c) Show a partial of MayLove’s statement of financial position as at 31 December 2016 to

present the information on its inventory.
(d) Assuming that at the year-end 2016, the account of Allowance to Reduce Inventory to
NRV had a credit balance of RM300,000. For the financial year end 2016, determine the
amount of the gain or loss that would be recorded due to the change in Allowance to
Reduce Inventory at Net Realisable Value. Prepare the related journal entry.

(e) Explain how the application of LCNRV approach may result inconsistency in terms of its
inventory measurement.

Suggested Answer

(a)

Item Quantity Cost NRV Lower-of-

per per Cost-or-
major major NRV per
group group major group
(RM) (RM) (RM)
Wooden Furniture 40 213,500 135,000 135,000
Bamboo Furniture 32 122,500 84,000 84,000
Rattan Furniture 40 178,500 65,000 65,000
Metal Furniture 40 21,500 35,000 21,500
Glass Furniture 56 50,000 70,000 50,000
Acrylic 40 25,000 15,000 15,000
Furniture
Final Inventory 370,500
Value

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(b)

Item Cost per Lower-of-

major Cost-or-
group NRV per Difference
(RM) major (RM)
group
(RM)
(ii)
Wooden Furniture 213,500 135,000 78,500
Bamboo Furniture 122,500 84,000 38,500
Rattan Furniture 178,500 65,000 113,500
Metal Furniture 21,500 21,500 None
Glass Furniture 50,000 50,000 None
Acrylic 25,000 15,000 10,000
Furniture
611,000 370,500 240,500

Journal Entries:

Dr Loss Due to Decline of Inventory to Net Realizable Value 240,500

Cr Allowance to reduce Inventory to Net Realizable Value 240,500

(c)

MayLove Bhd
Statement of Financial Position (Partial)
As at 31 December 2016

RM
Inventory 611,000
Allowance to reduce Inventory to Net Realizable Value 240,500
Inventory at net realizable value 370,500

(d) For the year ended 31 December, 2016, the gain that would be recorded due to the change in the
Allowance to Reduce Inventory to Net Realisable Value would be RM59,500, as calculated
below.
Balance prior to adjustment …………………………………….. RM300,000
Required balance …………………………………….. RM240,500
Gain to be recorded ……………………………………. RM 59,500

Journal Entry:
DR Allowance to Reduce Inventory to NRV 59,500
CR Recovery of Inventory Loss 59,500

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 Allowance to Reduce Inventory to NRV had a credit balance of 240,500

(e) Application of the rule results in inconsistency because a company may value the inventory at
cost in one year and at NRV in the next year.

QUESTION 3

Décor Home Bhd installs replacement siding, windows and louvered glass doors for
condominium complexes. The company is in the process of preparing its annual financial
statements for the fiscal year ended 31 May 2017. Mr. Eric Mun has gathered the data
concerning inventory. On 31 May 2017, the balance in Décor Home Bhd Inventory account was
RM408,000 and Allowance to Reduce Inventory to Net Realisable Value (NRV) had a credit
balance of RM27,500. Mr Eric Mun summarised the relevant inventory costs and market data on
31 May 2017 in the schedule below.

Inventory Cost (RM) Sales Price (RM) Net Realisable

Value (RM)
Aluminium siding 70,000 64,000 56,000
Cedar siding 86,000 94,000 84,800
Louvered glass doors 112,000 186,400 168,300
Thermal windows 140,000 154,800 140,000
Total 408,000 499,200 449,100

Décor Home Bhd applies the loss method and use an Allowance Account to record for the write
down of the inventory to net realisable value.

REQUIRED:

(a) Determine the proper balance in Allowance to Reduce Inventory to Net Realisable Value
Account on 31 May 2017.

(b) For the financial year end 31 May 2017, determine the amount of the gain or loss that
would be recorded due to the change in Allowance to Reduce Inventory at Net Realisable
Value. Prepare the related journal entry.

(c) Explain the definition of Net Realisable Value.

(d) Explain the rationale for the use of the LCNRV rules as it applies to inventories.

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Suggested Answer

(a) The balance in the Allowance to Reduce Inventory to NRV at May 31, 2017, should be
$15,200.

Cost NRV LCNRV

(RM) (RM) (RM)
Aluminum siding 70,000 56,000 56,000

Cedar siding 86,000 84,800 84,800

Louvered glass doors 112,000 168,300 112,000

Thermal windows 140,000 140,000 140,000

Totals $408,000 $449,100 $392,800

Inventory cost $408,000

LCNRV valuation 392,800

Allowance at May 31, 2017 $ 15,200

b. For the fiscal year ended May 31, 2015, the gain that would be recorded due to the change
in the Allowance to Reduce Inventory to Net Realizable Value would be $12,300.

Balance prior to adjustment …………………………………….. RM27,500

Required balance …………………………………….. (RM15,200)
Gain to be recorded ……………………………………. RM12,300

Journal Entry:
DR Allowance to Reduce Inventory to NRV 12,300
CR Recovery of Inventory Loss 12,300

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(c) NRV is the estimated selling price in the normal course business less estimated cost to
complete and estimated cost to make a sale.

(d) The use of the lower-of-cost-or-net realizable value (LCNRV) rule is based on both the
expense recognition principle and the concept of conservatism. The expense recognition
principle applies because the application of the LCNRV rule allows for the recognition of a
decline in the utility (value) of inventory as a loss in the period in which the decline takes
place.

The departure from the cost principle for inventory valuation is permitted on the basis of
conservatism. The general rule is that the historical cost principle is abandoned when the
future utility of an asset is no longer as great as its original cost.