Question

The text is talking about the valuation of lower of cost or market (net realizable value).

It provides an example of "Intel chips" in being devalued in the following way:

Intel Chips - [Qty] 1,000 [Cost per Item] $250 [Market Per Item] $200 [Lower of Cost or Market per item] $200 Total Lower of Cost or Market 1,000 x $200 = $200,000

This part makes sense. The text then indicates that the following effects of the lower of cost or market write-down (of the $50,000 dollars) are as follows:

Effects of LCM Write Down	Current Period	Next Period (if sold)
Costs of Goods Sold	Increase $50,000	Decrease $50,000
Pretax Income	Decrease $50,000	Increase $50,000
Ending Inventory on balance sheet	Decrease $50,000	Unaffected

Question: I am seeking an explanation as to why does the COGS and Pre-tax income change in opposition in the next period from the current period.

Please help with an explanation so that I may understand.

Answer 1

It is the ending stock to which the LCM is applied, as a result of which the ending stock will be stated at a lesser figure than the actual cost. The corollary of this is that, the COGS will be higher and pretax income will be lower. Please note that COGS = Beginning inventory+Purchases-Ending inventory. Lower ending inventory value will push up COGS.

The next year, the previous year'sending inventory (stated at a lower value) will become the beginning inventory. The effect of this (as per the above equation) will be opposite in nature.