Valuing inventory Cambridge IGCSE Accounting (9–1) revision
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In plain words
At the year end, the goods still unsold have to be given a value, because that figure goes into both the profit calculation and the statement of financial position. The rule is cautious: use what the goods cost, unless they can only be sold for less.
6 things to know
- Inventory is valued at the lower of cost and net realisable value. This applies prudence.
- Cost is the purchase price plus any costs of getting the goods to their present place and condition, such as carriage inwards.
- Net realisable value is the estimated selling price, less any costs still to be paid to complete or sell the goods.
- The rule is applied to each item, or each group of similar items, separately.
- If closing inventory is overvalued, cost of sales is too low, so gross profit and the profit for the year are overstated. Current assets and owner's equity are overstated too.
- This year's closing inventory is next year's opening inventory. An overvaluation this year overstates this year's profit and understates next year's.
Worked example
A shop has three types of goods. A: cost $500, net realisable value $650. B: cost $320, net realisable value $280. C: cost $150, and it can be sold for $200 after repairs costing $70. Find the value of the inventory.
- A: the lower of 500 and 650 is $500.
- B: the lower of 320 and 280 is $280.
- C: net realisable value = 200 − 70 = 130. The lower of 150 and 130 is $130.
- Total = 500 + 280 + 130 = $910.
Tips and tricks
- Take the lower figure item by item. Comparing total cost with total net realisable value gives the wrong answer.
- Closing inventory and profit move the same way: too high a valuation gives too high a profit.
It lands in your notebook with its questions as flashcards.
Valuing inventory: 5 questions and answers
These are the quiz’s questions. Do the quiz first, then come back here for the ones that got you.
How is inventory valued?
The cautious figure is used.
What is net realisable value?
It is what the goods will actually bring in.
An item cost $80 and has a net realisable value of $65. At what value is it included in inventory?
The lower of the two.
Closing inventory is overvalued by $500. What is the effect on gross profit?
Cost of sales is too low, so gross profit is too high.
Which accounting concept lies behind the rule for valuing inventory?
Assets and profit should not be overstated.
Quiz
5 questions
Tap an answer and you’ll see straight away whether it’s right, and why.
Worksheet
3 questions, 7 marks. Write your answers on paper, then check them.
Valuing inventory
Cambridge IGCSE Accounting (9–1) 0985 · 7 marks · papermunch.org
Name ______________________________ Date ______________
State the basis on which inventory should be valued, and the accounting concept it applies.[2]
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At the lower of cost and net realisable value. This applies the prudence concept.
Goods cost $900. They are damaged and can be sold for $1000 only after repairs costing $250. Calculate the value at which they should be included in inventory.[3]
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$750. Net realisable value = 1000 − 250 = 750, which is lower than the cost of 900.
Closing inventory was undervalued by $600. State the effect on the profit for the year and on current assets.[2]
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The profit for the year is understated by $600. Current assets are understated by $600.
Answers: Valuing inventory
- 1. At the lower of cost and net realisable value. This applies the prudence concept.
- 2. $750. Net realisable value = 1000 − 250 = 750, which is lower than the cost of 900.
- 3. The profit for the year is understated by $600. Current assets are understated by $600.