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Lower of Cost or Market quiz #1

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  • What is the rule of conservatism in accounting, and how does it affect the recording of asset values?
    The rule of conservatism requires accountants to record losses more readily than gains, meaning asset values are reduced immediately if they decline, but increases in value are only recognized upon sale.
  • How is the 'lower of cost or market' rule applied to inventory valuation?
    Inventory must be reported at the lower of its historical cost or its current market value, ensuring that potential losses are recognized promptly.
  • How is market value determined when applying the lower of cost or market rule to inventory?
    Market value is determined as either the net realizable value (estimated selling price minus disposal costs) or the current replacement cost, whichever is lower.
  • If inventory was purchased for $84,000 and its net realizable value is now $79,000, at what value should it be reported on the financial statements?
    The inventory should be reported at $79,000, the lower of its cost and net realizable value.
  • What journal entry is made when inventory is written down under the lower of cost or market rule?
    A loss from write-down of inventory is debited for the amount of the decrease, and inventory is credited to reduce its book value.
  • Why are gains in asset value not recognized until the asset is sold, according to the rule of conservatism?
    Gains are not recognized until sale to avoid overstating assets and income, ensuring financial statements remain conservative and reliable.
  • What is net realizable value, and how is it calculated for inventory valuation purposes?
    Net realizable value is the estimated selling price of inventory minus any costs required to sell or dispose of it.
  • What does the rule of conservatism require when recording changes in asset values?
    The rule of conservatism requires that losses in asset value are recorded immediately, while gains are only recognized when the asset is sold.
  • How do you determine the value at which inventory should be reported under the lower of cost or market rule?
    Inventory should be reported at the lower of its historical cost or its market value, where market value is the net realizable value or current replacement cost, whichever is lower.
  • What is the journal entry when inventory is written down under the lower of cost or market rule?
    A loss from write-down of inventory is debited for the amount of the decrease, and inventory is credited to reduce its book value.