WRENCROFT APPLIANCE COMPANY

PROBLEM

In 1989, Auditors of Wrencroft Appliance Company (WAC) proposed two different inventory write-downs regarding a discontinued microwave product and spare parts to the company’s audit committee. John Moore, WPC‘s CFO, is in the position to make recommendations to the board regarding the proposed adjustments. He needs to make a careful evaluation of whether the proposed inventory write-downs are necessary for the independent accountants to render unqualified opinion. In order to make sound recommendations to audit committee, John should analyze on the following matters.

1.) Are the reflected amounts in the proposed write-downs based on reasonable estimates?
2.) Is there a sufficient evidence for either write-downs to justify corresponding tax deductions?

ANALYSIS

Inventory valuation & Estimates for proposed write-downs

Discontinued Microwave
WPC’s auditor used Lower of Cost or Market (LCM) method as basis for inventory valuation in the proposal given. The discontinued microwave oven was proposed to be adjusted to 40% of the finished goods inventory of 1988 due to the anticipation of selling the units to a large discount chain with an agreement to receive 40% of the cost of the microwaves, while the spare parts manufactured for the microwaves should be disposed of at 5% scrap value. The necessity to write down this bulk of inventory favors tax deduction for the company’s advantage. However the case did not imply that there is an evident market price reduction of the microwaves, while it may be a considered as slow-moving item because it is privately labeled, there is actually no harm if the company won’t write this down. However, for purposes of compliance to GAAP LCMI inventory valuation, disclosure relevant to the value of the inventory it must be considered. Although microwaves are not subject to