Draper Company's Controller Was Explaining to the Company's President, Dana

question 44

Essay

Draper Company's controller was explaining to the company's president, Dana Draper, that if the inventory's value should decrease below its original cost, the inventory must be written down and a loss must be recognized. The controller told the president that this is called the lower of cost or market rule. The president was unclear as to the purpose of this rule and wanted to know the disadvantages of this method.
Required:
a. State the accounting convention that supports the lower of cost or market rule, and in this context, discuss the purpose of the rule.
b. Discuss the criticisms of the lower of cost or market rule in the valuation of inventories.

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Definitions:

Investing Activities

Transactions and events related to the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Cash Flows

The total amount of money being transferred into and out of a business, especially as affecting liquidity.

Financing Activities

Transactions with creditors or investors used to fund either company operations or expansions. These include issuing bonds, obtaining loans, repaying debt, and issuing or buying back shares.

Cash Dividends

Payments made in cash by a corporation to its shareholder members from its earnings.