Inventory Cost or Net Realisable Value
A retailer holds three inventory lines at 30 June. Line X cost $8,000 and can be sold for $9,600 after selling costs of $600. Line Y cost $5,000 and, due to a change in fashion, can now be sold for $4,200 after selling costs of $400. Line Z cost $3,000 and is expected to sell for $3,800 after selling costs of $200, but the supplier has just announced a price increase meaning replacement cost is now $3,400. The owner argues that because total inventory can be sold for more than total cost, no write-down is needed. The draft balance sheet shows inventory at $16,000.
1. Apply the lower of cost and net realisable value rule line by line and determine the correct inventory figure.
Read the worked answer
NRV = expected selling price less costs to complete and sell. Line X: NRV $9,600 − $600 = $9,000, which exceeds cost $8,000, so carry at $8,000. Line Y: NRV $4,200 − $400 = $3,800, below cost $5,000, so carry at $3,800 and recognise a $1,200 write-down. Line Z: NRV $3,800 − $200 = $3,600, above cost $3,000, so carry at $3,000; replacement cost is irrelevant under this rule. Correct inventory = $8,000 + $3,800 + $3,000 = $14,800. The owner's aggregate argument is wrong: the rule is applied item by item (or at least by group), because gains on one line cannot offset losses on another - that would overstate assets and profit.
2. State the effect of the correction on profit, assets and equity, and explain why the write-down is recognised now rather than when the goods are sold.
Read the worked answer
Inventory falls from $16,000 to $14,800, a reduction of $1,200. This flows through cost of goods sold as a write-down expense, reducing profit by $1,200, reducing assets by $1,200 and reducing equity by $1,200 (via retained profit). The write-down is recognised now because the loss of value has already occurred at reporting date; the NRV test is a reporting-date assessment, and deferring it would overstate inventory and profit in this period and understate the loss in the next. Recognising it now satisfies faithful representation and prudence, and matches the expense with the period in which the decline in value arose.