Inventory Valuation and Cost of Sales
What the exam tests
This domain tests inventory cost, net realisable value, cost of sales and the effect of closing inventory on profit. Expect FIFO or weighted average calculations and write-downs.
Core rules
- Inventory is measured at the lower of cost and net realisable value (NRV).
- Cost includes purchase price, carriage inwards and conversion costs; it excludes selling costs and abnormal waste.
- Cost of sales = opening inventory + purchases - closing inventory.
- A write-down to NRV increases cost of sales and reduces profit.
- Closing inventory is a current asset, not an expense of the current year.
Worked example
Opening inventory is 2,000, purchases are 10,000 and closing inventory at cost is 3,000. Cost of sales = 2,000 + 10,000 - 3,000 = 9,000. If the closing inventory's NRV is only 2,600, write it down by 400. Closing inventory becomes 2,600 and cost of sales becomes 9,400. Profit falls by 400 because the closing inventory asset is lower.
Traps
Do not value inventory at selling price. Do not include carriage outwards in inventory cost; carriage inwards is included. Do not forget to adjust cost of sales for the write-down. Do not treat closing inventory as a purchase. Do not ignore goods held on sale or return if the business still bears the risks and rewards.
Key points
- Inventory is valued at the lower of cost and NRV.
- Cost of sales = opening inventory + purchases - closing inventory.
- Write-downs increase cost of sales.
- Closing inventory is a current asset.