Lower-of-Cost-or-Market Garcia Home Improvement Company installs replacement siding, windows, and louvered glass doors for single family homes and condominium complexes in northern New Jersey and southern New York. The company is in the process of preparing its annual financial statements for the fiscal year ended May 31, 2010, and Jim Alcide, controller for Garcia, has gathered the following data concerning inventory. At May 31, 2010, the balance in Garcia Raw Material Inventory account was $408,000, and the Allowance to Reduce Inventory to Market had a credit balance of $27,500. Alcide summarized the relevant inventory cost and market data at May 31, 2010, in the schedule below. Alcide assigned Patricia Devereaux, an intern from a local college, the task of calculating the amount that should appear on Garciaâ May 31, 2010, financial statements for inventory under the lower-of-costor- market rule as applied to each item in inventory. Devereaux expressed concern over departing from the cost principle.
(a) (1) Determine the proper balance in the Allowance to Reduce Inventory to Market at May 31, 2010.
(2) For the fiscal year ended May 31, 2010, determine the amount of the gain or loss that would be recorded due to the change in the Allowance to Reduce Inventory to Market.
(b) Explain the rationale for the use of the lower-of-cost-or-market rule as it applies to inventories.