Awards Etc. carries an inventory of trophies and ribbons for local sports teams and school clubs. The cost of trophies has dropped in the past year, which pleases the company except for the fact that it has on hand considerable inventory that was purchased at the higher prices. The president is not pleased with the lower profit margin the company is earning. “The lower profit margin will continue until we sell all of this old inventory,” he grumbled to the new staff accountant. “Not really,” replied the accountant. “Let’s write down the inventory to the replacement cost this year, and then next year our profit margin will be in line with the competition.”

Required
Explain why the inventory can be carried at an amount less than its cost. Which accounts will be affected by the write-down? What will be the effect on income in the current year and future years?