Inventory Valuation Issues
Response to the following problem:
Hanlon Company purchased a significant amount of raw materials inventory for a new product that it is manufacturing. Hanlon purchased insurance on these raw materials while they were in transit from the supplier
Hanlon uses the lower of cost or market rule for these raw materials. The replacement cost of the raw materials is above the net realizable value and both are below the original cost
Hanlon uses the average cost inventory method for these raw materials. In the last two years, each purchase has been at a lower price than the previous purchase, and the ending inventory quantity for each period has been higher than the beginning inventory quantity for that period.
Required:
1. Explain the theoretically appropriate method that Hanlon should use to account for the insurance costs on the raw materials while they were in transit from the supplier.
2. a. Explain the amount at which Hanlon should report the raw materials inventory on its balance sheet.
b. In general, explain why the lower of cost or market rule is used to report inventory.
3. Explain what would have been the effect on ending inventory and cost of goods sold had Hanlon used the LIFO inventory method instead of the average cost inventory method for the raw materials.