1. In applying LCM, market cannot be
a. less than net realizable value
b. greater than the normal profit
c. less than the normal profit margin
d. greater than net realizable value
2) For a journal entry with only two lines, the following entry is valid: Increase in a liability, Increase in an Expense.
A) True
B) False
Sol185:
- In applying LCM, market cannot be: Answer: a. less than net realizable value.
Lower of Cost or Market (LCM) is an accounting method for valuing inventory. Under LCM, inventory is recorded at the lower of its historical cost or market value. Market value is defined as the current replacement cost of the inventory, subject to a ceiling and a floor. The ceiling is the net realizable value (NRV), or the estimated selling price less any estimated selling expenses. The floor is the net realizable value less a normal profit margin. Therefore, market value cannot be less than the net realizable value.
- For a journal entry with only two lines, the following entry is valid: Increase in a liability, Increase in an Expense. Answer: True.
A journal entry with two lines is called a simple entry. In this type of entry, the debit and credit amounts are recorded in different accounts. The accounting equation (Assets = Liabilities + Equity) must remain in balance for each transaction. An increase in a liability is recorded as a credit, and an increase in an expense is recorded as a debit. Therefore, the entry “Increase in a liability, Increase in an Expense” is a valid simple entry.
The correct answer and explanation is:
Correct Answers and Explanations
1) In applying LCM, market cannot be:
Answer: d. greater than net realizable value.
The Lower of Cost or Market (LCM) method ensures inventory is reported at the lower value between its original cost and the market value. “Market” refers to the current replacement cost of inventory but is subject to a ceiling and a floor:
- Ceiling (Upper Limit): Net Realizable Value (NRV), which is the estimated selling price minus any costs to sell or complete the product.
- Floor (Lower Limit): NRV minus the normal profit margin.
This means that market value cannot be greater than NRV, as this would overstate the inventory’s value, potentially misleading financial statement users.
2) For a journal entry with only two lines, the following entry is valid: Increase in a liability, Increase in an Expense.
Answer: True.
A journal entry must maintain the fundamental accounting equation: Assets=Liabilities+Equity\text{Assets} = \text{Liabilities} + \text{Equity}
Every transaction involves at least one debit and one credit.
- An increase in an expense is recorded as a debit, since expenses reduce net income and equity.
- An increase in a liability is recorded as a credit, as it represents an obligation to pay.
A valid example of this entry:
- Debit Expense (e.g., Interest Expense)
- Credit Liability (e.g., Interest Payable)
This entry correctly reflects that the company is recognizing an expense while also increasing a corresponding liability. This is common for accrued expenses, such as wages payable or interest payable.
Now, generating the requested image.
Here is the generated image illustrating the Lower of Cost or Market (LCM) method and a journal entry demonstrating an increase in liability and an increase in expense. Let me know if you need any modifications or additional details!
