Question

Charlie Company sells tires. Charlie has discovered that some of its tires have been destroyed. Prior to that, the market value of the destroyed tires was estimated at $1,500,000 and the book value was $1,000,000. Which of the following describes the necessary adjustments to Charlie’s financial statements as a result of this discovery?

a) Net income and inventory reductions of $1,000,000 respectively.

b) Property, plant and equipment and net income reductions of $1,000,000, respectively.

c) Inventory reduction of $1,500,000, net income reduction of $1,000,000 and other comprehensive income reduction of $500,000.

d) Property, plant and equipment reduction of $1,000,000, net income reduction of $1,500,000 other comprehensive income increase of $500,000.

e) Inventory and net income reductions of $1,500,000 respectively.

Answer 1

Damaged inventory is valued at lower of fair market value or book value whichever is lower. Fair market value refers to current purchase price for the same inventory item. As per facts given in question book value (1000000) is lower compared to fair market value (1500000).Hence loss to be recorded at book value which equals to 1000000.

Since inventory (tire) was destroyed results in reduction in closing inventory and thereby reduce gross profit and thereby net profit.

Hence correct answer is Option A – Net income and Inventory reduction of $1000000 respectively.