Better Buy Inc.has six CD players in inventory on December 31.The players were purchased in November for $170.The price lists from suppliers indicate the current replacement cost of a CD player to be $168.What is the effect on gross profit if Better Buy values its ending merchandise inventory using the lower-of-cost-or-market rule?

Question

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The lower-of-cost-or-market rule requires companies to value their inventory at the lower of its cost or its replacement cost. In this case, the replacement cost of the CD players is $168, which is lower than the cost of $170. Therefore, if Better Buy values its ending merchandise inventory using the lower-of-cost-or-market rule, the value of each CD player in inventory will be adjusted to $168, resulting in a total decrease in inventory value of $12 (6 x $2). This decrease in inventory value will reduce the gross profit by the same amount, resulting in a decrease of $12.