Central Incorporated has two items in inventory as of December 31, 2017. Each item was purchased for $40. Company management chose to write down Item 1 to $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 2018, each item was sold for $50 cash.
a. Prepare journal entries for each activity (i.e., 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 2017 and 2018.
c. Explain how management could manipulate reported earnings when applying the lower-of-cost-or-market rule.