Client Understanding Paper
April 10, 2012
Client Understanding Paper
Dear Client, please find below the detailed written explanation on the topics you requested. The items addresses are as follows:
1. Adjusting lower cost or market inventory on valuation.
2. Capitalizing interest on building construction.
3. Recording gain or loss on asset disposal.
4. Adjusting goodwill for impairment.
Adjusting lower cost or market inventory on valuation
The term “inventory” applied to all the goods/materials that are acquired with the intention to resale to make profits, which includes:
* “Are held for sale in ordinary course of business.
* Are in process of ...view middle of the document...
e., estimated selling price in the ordinary course of business less reasonably predictable cost of completion and disposal), and
* Market should not be less than net realizable value reduced by an allowance for an approximately normal profit margin (Schroeder, Clark, & Cathey, 2011, p. 268).
Companies usually record inventories at their purchased price. Conservatism requires organization to mark down the inventories at the market value if the market value is below the purchase cost. US GAAP also acknowledge that if the inventory prices are falling than future selling prices would also decline. To represent the same, loss because of decline in prices should immediately recognize in the current period.
In case of not adhering to LCM valuation method, if the organization continue to record the purchase cost as the basis of valuation, then it would result in overstated current assets on financial statement and working capital calculation would be totally distorted.
Capitalizing interest on building construction
This concept of GAAP handles the interest expense incurred because of borrowed funds for the construction of asset. Usually assets are recorded at their historical or acquired cost and there cost has been allocated over its useful life but in case of building construction, there are multiple costs associated with the construction such as labor, supplies, and other overheads (including interest) that an organization incurred over the period of time.
One of the cost associated with building construction is the interest cost that is, the cost organization could avoid if it would not decide to construct a building. There were many theories in the past tried to justify the recognition of the interest expense but none of them were appropriate according to matching principle. In year 1979, the FASB issued SFAS No.34, “Capitalization of Interest Costs” to record interest expense incurred during the construction period of assets. The objective of this release by FASB was to provide guidance to recognize the interest cost as significant part of the cost of the asset, and it should be capitalized only when the asset requires a period of time to build for its intended use. It also classified the assets that are eligible for interest capitalization, such as:
* “Assets that are constructed or otherwise produced for an enterprise’s own use
* Assets intended for sale or lease that are constructed or otherwise produced as discrete projects” (Schroeder, Clark, & Cathey, 2011, p. 287).
This release provided the guidelines to capitalize all interest expense until the asset is ready to use and expense the interest after the asset in use.
Recording gain or loss on asset disposal
Assets are considered to generate future cash flows to the organization and have future service benefits. When organization acquires the asset it does not expense the entire cost right away but allocate the cost of the asset over its useful life...