Client Understanding Memo

To: President Adams

From: Jack Firth

Date: January 9, 2011

Subject: Financial Statement Analysis

In connection with our ongoing audit for the company’s financial statements for the year ended December 31, 2010, the previous years’ work papers have to be reviewed for the following reasons:

Adjusting lower cost of market inventory on valuation

The policies of the company on the valuation of its inventory have to be reviewed on whether it is in compliance with generally accepted accounting principles. Moreover, this will also help the audit team determine how the company computes the cost for its inventories and the current market cost. Specifically, GAAP requires that all inventories be stated and valued using either the cost or the market value method, whichever is lower. According to FSP ARB 43-a, inventory is “the aggregate of those items of tangible personal property which (1) are held for sale in the ordinary course of business, (2) are in process of production for such sale, or (3) are to be currently consumed n the production of goods or services to be available for sale” (Notice for Recipients of This Proposed FASB Staff Position). These requirements need to be met in order to be in compliance with GAAP and the SEC.

The inventories for the company are also subject to an upper boundary called the ceiling as well as a lower boundary called the floor. The ceiling is applied to the market value of inventory to ensure that the market value is below the net realizable value. The NRV is “a method of determining the present value of a troubled asset to its present owner based on the assumption that the asset will be held for a period of time and sold at some future date” (TeachMeFinance, 2005). The NRV at the ceiling is used to ensure that a company cannot overstate the value of its inventory. The NRV is also used at the floor. The stated market value must not be lower than the NRV minus the costs of the sale of the asset. The...