Valuation of Inventory (Copy)
Cheat Sheet: 4.5 Valuation of Inventory
O Level and IGCSE Accounting – Quick Revision
Key Definitions
| Term | Definition |
|---|---|
| Inventory | Goods held for resale or use in production. |
| Cost | The original purchase price of the inventory including expenses like transport. |
| Net Realisable Value (NRV) | The expected selling price minus expenses to complete/sell the inventory. |
| Lower of Cost and NRV | The basis of valuing inventory to follow the prudence concept. |
Inventory Valuation Rule
Inventory is always valued at the LOWER of:
- Cost
- Net Realisable Value (NRV)
This ensures:
- Assets are not overstated
- Profits are not overstated
- The Prudence Concept is applied
Example: Inventory Valuation
| Item | Cost ($) | NRV ($) | Valued At ($) |
|---|---|---|---|
| Item A | 100 | 120 | 100 |
| Item B | 150 | 130 | 130 |
| Item C | 80 | 90 | 80 |
| Total | 310 |
Final Inventory Valuation = $310
Inventory Valuation Statement Format
Inventory Valuation as at [Date]
| Item Description | Quantity | Cost per Unit ($) | NRV per Unit ($) | Valuation ($) |
|---|---|---|---|---|
| Item A | 10 | 10 | 12 | 100 |
| Item B | 5 | 30 | 28 | 140 |
| Item C | 8 | 15 | 17 | 120 |
| Total | 360 |
Effect of Incorrect Inventory Valuation
| Error | Effect on Accounts |
|---|---|
| Overstated Closing Inventory | – Overstated Gross Profit- Overstated Profit for the Year- Overstated Equity- Overstated Current Assets |
| Understated Closing Inventory | – Understated Gross Profit- Understated Profit for the Year- Understated Equity- Understated Current Assets |
Impact on Gross Profit
Formula:
- Gross Profit = Sales – Cost of Sales
- Cost of Sales = Opening Inventory + Purchases – Closing Inventory
If Closing Inventory is Overstated, Cost of Sales is Understated → Gross Profit is Overstated
If Closing Inventory is Understated, Cost of Sales is Overstated → Gross Profit is Understated
Key Concept: Prudence Principle
- Inventory should not be valued above its expected benefit.
- Prevents overstating of assets and profits.
- Encourages conservative reporting.