Central Incorporated has two items in inventory as of December 31, 2011. Each item was purchased for $40. Company management chose to write down Item # 1 $28, which at year end was assessed to be its market value. Management did not write down Item #2 because its market value was estimated to be greater than $40. During 2012, each item was sold for $50 cash.
a. Prepare journal entries for each activity (ie., the write-down, the sale of Item #1, and the sale of Item #2).
b. Compute the profit or loss associated with each item in 2011 and 2012.
c. Explain how management could manipulate reported earnings when applying the lower-of-cost-or-market rule.