Inventory Valuation and the Slow-Moving Stock Line
Groothandel Lindemans BV sells garden equipment. At year-end its inventory includes 400 units of a patio heater model bought at €85 each. The supplier has since launched a newer model, and Lindemans can only sell the old units at €70 each. Selling costs are estimated at €8 per unit. The bookkeeper values the stock at cost, €34,000, because 'we paid that price'. A second line, 200 units of a barbecue bought at €60 each, is currently selling well at €95; the replacement cost has risen to €70, but the selling price is unchanged. The controller asks whether the lower of cost and net realisable value rule applies to each line, and whether the barbecue line should be written up to replacement cost. The company also has a purchase commitment for 100 more patio heaters at €85 each, signed before the new model launch.
1. Calculate the correct carrying amount for the patio heater line and explain the principle applied.
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Inventory is measured at the lower of cost and net realisable value (IAS 2). Net realisable value is the estimated selling price less the estimated costs of completion and sale: €70 − €8 = €62 per unit. Cost is €85, so the lower figure is €62. The 400 units should be carried at 400 × €62 = €24,800, not €34,000. The write-down is €34,000 − €24,800 = €9,200 and is recognised as an expense in the period. The fact that €85 was paid is irrelevant once the net realisable value has fallen below cost; the purpose of the rule is to prevent assets being carried above the amount they can recover.
2. Should the barbecue line be written up to its higher replacement cost of €70?
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No. The lower of cost and net realisable value rule never allows inventory to be carried above cost. The barbecue's net realisable value (€95, less any selling costs) is above its cost of €60, so it stays at cost: 200 × €60 = €12,000. A rise in replacement cost does not create a write-up under this rule. The only situation where replacement cost might be relevant is under a different measurement convention, but under IAS 2 the ceiling is cost. Writing up would overstate profit and assets.
3. How should the purchase commitment for 100 patio heaters at €85 be treated at year-end?
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The commitment is an executory contract: neither the goods nor the obligation to pay has yet been recognised as an asset or liability. However, because the committed purchase price of €85 exceeds the net realisable value of €62, the contract is onerous. The expected loss is 100 × (€85 − €62) = €2,300, which should be recognised as a provision and an expense at year-end. This is separate from the write-down on the 400 units already in stock. The combined effect on profit is the €9,200 write-down plus the €2,300 provision, a total of €11,500, which is well above any reasonable materiality threshold and must be corrected before the accounts are finalised.