MALING, ELLEINE ROSE QUADRA Submission Date

BSA 2-A Cost Accounting and Control

PRE-ASSESSMENT EXAMINATION

Instruction(s): Answer the following cases below and use the enumerated general guide in responding to
each requirement.

● Minimum of 3 sentences and a maximum of 10 sentences will be strictly observed.

● Please cite your references using APA 7th edition1.
● References must be in the footnotes.
● Copy pasting as a practice is not accepted.
● Please do not alter this format.

CASE 1:

You have been asked by the financial vice president to develop a short presentation on the LCNRV method
for inventory purposes. The financial VP needs to explain this method to the president because it appears
that a portion of the company’s inventory has declined in value.

Instructions
The financial vice president asks you to answer the following questions.
(a) What is the purpose of the LCNRV method?

The NRV of items is the expected selling price minus the cost of sale or disposal. It is used to
calculate the lower of cost or NRV for on hand inventory items. If inventory is carried on the
accounting records at a cost larger than its net realizable value, a writedown from the recorded
cost to the NRV is made. The LCNRV method allows businesses to report losses by writing down
the value of affected inventory items, and this loss is charged against revenue and is also included
or buried in the Cost of Goods Sold. Furthermore, writing down inventory prevents a company
from carrying forward any losses for future recognition.2

(b) What is meant by “net realizable value”?

Net realizable value is a method used in inventory accounting that takes into account the total
amount of money that the inventory may generate if sold less the estimated selling costs. The
charges, fees, and taxes related with the sale or disposal of goods are referred to as the selling
costs. NRV is used to get the estimated value of the ending inventory.3

1
Click on this link to know how to cite references using APA Style of referencing, 7 th edition.
https://libguides.csudh.edu/citation/apa-7
2
Lower Of Cost Or Net Realizable Value. (n.d.). Retrieved from https://www.principlesofaccounting.com/chapter-
8/lcnrv-adjustments/
3
What is Net Realizable Value (NRV)?. (n.d.). Retrieved from
https://corporatefinanceinstitute.com/resources/knowledge/valuation/net-realizable-value-nrv/
 (c) Do you apply the LCNRV method to each individual item, to a category, or to the total of the
inventory? Explain.

The LCNRV rule can be applied on an individual item, category basis, or total inventory basis. What
basis entity must utilize is determined by the nature of the inventory and management policy. For
example, if a product can be sold individually and its selling price and related expenses can be
established independently, the LCNRV rule will be applied on an individual basis for that product.
If a product's NRV cannot be assessed on an individual basis because it must be sold together with
other products as a package, the rule will be applied on a group basis. Furthermore, if an entity
controls inventory as a whole, the rule will be applied on a totality basis to all forms of inventory
combined. If a company utilizes category basis or total inventory basis in determining LCNRV,
increases in market prices tend to offset decreases in market prices. 4

(d) What are the potential disadvantages of the LCNRV method?

It decreases the value of an asset and does not recognize expenses in the selling period, but rather
in the period of loss. On the other hand, it raises the asset value at the time of sale. The LCNRV
technique does not allow for consistency, resulting in income fluctuations. Second, net realizable
value can indicate an asset's future economic benefits. The NRV cannot be calculated with
accuracy. This strategy is only utilized when there is strong evidence that reveals a decrease in
inventory price, which results in a loss when the inventory is sold. 5

(e) What method(s) might be used in the accounts to record a loss due to a price decline in the
inventories? Discuss.

The two methods used in recording loss due to a price decline in the inventories are direct method
or also called cost of goods sold method, and allowance method or also known as loss method.
Under the direct method, inventory will be recorded at the lower of cost or net realizable
value(LCNRV). Any loss on inventory writedown will not be accounted for separately but is already
included or buried in the cost of goods sold thus the other term “cost of goods sold method”. For
allowance method, the inventory will be recorded at cost and any loss on inventory writedown
will be accounted for separately by debiting “loss on inventory writedown” and crediting
“allowance for inventory writedown”. 6

4
Valix, C., et al. (2020). Intermediate Accounting 2020 Edition. GIC Enterprise & Co., Inc.
Chapter 9 Inventories: Additional Valuation Issues. (2010). Retrieved from
https://cpadiary.files.wordpress.com/2015/06/ch09-invenories-addtl.pdf
5
Daraghma, Z. (2018). Expectation Gap in Applying the IAS 2 [Inventories]. Retrieved from
https://www.abacademies.org/articles/expectation-gap-in-applying-the-ias-2-inventories-evidence-from-
palestine-7200.html
6
Lopienski, K. (2021). Inventory Write-Downs Explained: Accounting Methods, Tips, and Best Practices. Retrieved
from https://www.shipbob.com/blog/inventory-write-down/
Tuovila, A. (2021). Inventory Write-Off. Retrieved from https://www.investopedia.com/terms/i/inventory-write-
off.asp
 (f) What factors might call for inventory valuation at net realizable value?

Inventory valuation at net realizable value may occur when there is a regulated market with a
quoted price for specific goods. Another consideration is that there are no major disposal costs.
Some examples are agricultural products and precious metals. Some of these products which can
be sold promptly at specified prices are frequently appraised at net realizable value. 7

CASE 2:

On inventory estimation: Why do companies experience problems when valuing inventories?

Present your answer using IBC (Introduction, Body, Conclusion) Format. Minimum of 5 sentences if
required for each part. You can refer your answer from this journal article: https://www.diva-
portal.org/smash/get/diva2:207153/FULLTEXT01.pdf or you can explore more from the internet.

At the end of each fiscal year, inventory is valued in order to compute the cost of goods sold and the cost
of unsold inventory. This is critical because an excess or shortage of inventory has an impact on a
company's production and profitability. An inventory valuation enables a business to assign a monetary
value to goods in its inventory. Inventories are typically a company's largest current asset, and good
inventory assessment is required to provide accurate financial statements. If inventory is not adequately
measured, expenses and revenues cannot be appropriately matched, and a business may make poor
business decisions as a result. A corporation will select between a perpetual or a periodic inventory
accounting system. Accounting records in perpetual inventory must show the amount of inventory on
hand at all times. The periodic inventory is not kept up to date on a regular basis. While performing a
physical inventory is the best approach to evaluate goods, it is difficult or impractical in many business
operations. In such a case, an estimate of the inventory cost is required. The retail inventory technique
and the gross profit method are two ways for estimating inventory cost. However, one of the major issues
with inventory valuation originates from inaccurate inventory procedures and discrepancies between the
physical inventory balance and the one recorded in the system/books.

These problems may result from errors in recording of inventory due to unauthorized issuance of
materials, and incorrect recording of transactions like sales and purchases. Troubles in receiving products,
identifying and dispatching products to storage, holding goods, picking goods, and collecting and
dispatching shipments may also result in problems in valuing inventories. Also, the inventory value issue
does not present in the price element. The majority of issues are related to quantity and this is because
the daily routines like those mentioned above, were found to be inaccurate and insufficient, resulting in
discrepancies between the physical count of inventory and the quantity recorded in the system. Another
reason why problems are encountered in valuation of inventories is due to the method of estimation used.
When using gross profit method, the gross profit percentage is an important component of the
computation, although it is reliant on a company's prior performance, if the current circumstance results

7
Kimmel, P. et al. (2010). Financial Accounting. Tools for Business Decision Making. Retrieved from
https://books.google.com.ph/books?id=GIkfP1JxcHkC&lpg=PA331&ots=02hwLYSMhz&dq=Similar%20to%
20GAAP%2C%20under%20IFRS%2C%20certain%20agricultural%20products%20and%20mineral%20produ
cts%20can%20be%20reported%20at%20NRV.&pg=PA331#v=onepage&q&f=false
in a different proportion, then the gross profit percentage utilized in the computation is wrong. Also, the
calculation assumes that the historical gross profit percentage includes the long-term rate of losses due
to theft, obsolescence, and other reasons. If not, or if these losses have not previously been identified,
the calculation will almost certainly result in an incorrect estimated ending inventory. While for retail
inventory method, it works only if your markup is uniform across all products sold and does not work if
an acquisition has been performed and the acquiree retains huge volumes of merchandise at a much
different markup percentage than the acquirer.

The optimum inventory valuation technique must be chosen carefully because it has a direct impact on
the company's gross margin. Your decision can have a significant impact on your cost of goods sold, net
income, and ending inventory. As a business owner, you must evaluate each approach and select the one
that accurately shows the periodic income and is appropriate for your individual business circumstances.
In addition, a corporation must minimize faults or issues in the process of recording inventories and other
warehouse activities as much as possible to avoid further mishaps in the value of inventories. Remember
that the ending inventory for the current period will be the beginning inventory for the next period. Thus,
inaccurate inventory valuation in the present will result to incorrect financial statement not just for the
current period but also for the succeeding period. It is also crucial to remember that switching from one
technique of inventory valuation method to another will produce complications.