18.7 Lower of Cost and Net Realisable Value
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The document discusses the accounting principle of lower of cost or net realizable value for inventory valuation. It provides an example of a retailer with leftover iPods that can now only be sold for less than what the retailer paid. Inventory should be recorded at the lower of what was originally paid for the inventory (cost) or the amount it can now be sold for (net realizable value), which may require a write down. The document outlines how to calculate net realizable value and provides a numerical example where coats in inventory will be written down from $50 original cost to the lower $38 net realizable value.
18.7 Lower of Cost and Net Realisable Value
- 1. 18.7 LOWER OF COST AND NET REALISABLE VALUE
- 2. © Michael Allison, Trinity Grammar School. Author’s permission required for external use 18.7 LOWER OF COST AND NET REALISABLE VALUE Example: a retailer purchased 10,000 iPods in 2006 thinking they could be sold easily for the next 10 years. The iPods cost the retailer $250 each. The retailer didn’t anticipate the iPhone making the iPod obsolete, and today the retailer has 1,000 iPods left that can be sold for only $150 each. How should these be valued today? 2006 Cost of Stock $250 Current Selling Price $150 Vs. Relevance? Reliability? Historical Cost? Conservatism? Consistency?
- 3. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Inventory is not always valued at its “cost” price. Sometimes, the amount stock can be sold for is less than it actually costs Example… hotel rooms $199 Usual cost of 1 room at Hotel Windsor site $149 Today’s rate at lastminute.com.au 18.7 LOWER OF COST AND NET REALISABLE VALUE
- 4. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Example… David Jones swimwear in June, July and August Why is swimwear on sale this time every year? 18.7 LOWER OF COST AND NET REALISABLE VALUE
- 5. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Why do businesses sell stock for less than its cost? Sometimes a business will sell an item of stock for less than its cost because the item of inventory: Has been superseded by a newer model, e.g. old model iPhone Has become obsolete, e.g. typewriters, CDs Is out of season, e.g. selling umbrellas during summer Is out of fashion, e.g. wrong colour for this season Is damaged or spoiled, e.g. bread, fruit, vegetables Is being deliberately sold below cost, e.g. discounting to attract customers, selling tickets that would otherwise go to waste 18.7 LOWER OF COST AND NET REALISABLE VALUE
- 6. © Michael Allison, Trinity Grammar School. Author’s permission required for external use In Accounting, the rule for inventory valuation is: Inventory should be valued at the lower of: Cost Net Realisable Value (NRV)or 18.7 LOWER OF COST AND NET REALISABLE VALUE The item’s Product Cost
- 7. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Net realisable value (NRV) is: The estimated selling price of an item of inventory, less any costs incurred in Selling Marketing or Distributing the stock to the customer NRV = Estimated selling price of stock Selling, marketing and distribution costs 18.7 LOWER OF COST AND NET REALISABLE VALUE
- 8. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Net realisable value (NRV) example: On 1 December a firm has 100 coats in stock. The Product Cost of each coat is $50 How much should the coats be valued for in the firm’s Balance Sheet? To sell the coats in summer, the selling price has been lowered to $40 In addition, an advertisement costing $200 has been taken out in the local newspaper advertising the sale (for 100 coats) $50? $52? $40?$38?$42? 18.7 LOWER OF COST AND NET REALISABLE VALUE Inventory should be valued at the lower of: Cost Net Realisable Value (NRV)or
- 9. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Cost = $50 NRV = Estimated selling price of stock Selling, marketing and distribution costs$40 $2 $38= 18.7 LOWER OF COST AND NET REALISABLE VALUE Net realisable value (NRV) example: On 1 December a firm has 100 coats in stock. The Product Cost of each coat is $50 To sell the coats in summer, the selling price has been lowered to $40 In addition, an advertisement costing $200 has been taken out in the local newspaper advertising the sale (for 100 coats)
- 10. © Michael Allison, Trinity Grammar School. Author’s permission required for external use or In Accounting, the rule for inventory valuation is: So the coats will be valued at… 18.7 LOWER OF COST AND NET REALISABLE VALUE Inventory should be valued at the lower of: Cost Net Realisable Value (NRV)or Cost = $50 NRV = $38 This is called a Stock Write Down of $12
- 11. © Michael Allison, Trinity Grammar School. Author’s permission required for external use 18.7 LOWER OF COST AND NET REALISABLE VALUE Income Statement Revenue $ $ Cash sales 100000 Credit sales 20000 120000 less Cost of Goods Sold Cost of sales 48000 Import duties 2000 50000 Gross Profit 70000 less Stock loss 900 Stock write down XXXX Adjusted Gross Profit 68700 less Other Expenses Rent 3000 Insurance 2400 5400 Net Profit 63300 Stock Write Down is an Expense Hence, it must be reported in the Income Statement It is listed in between Gross Profit and Adjusted Gross Profit along with stock loss/gain Income Statement Revenue $ $ Cash sales 100000 Credit sales 20000 120000 less Cost of Goods Sold Cost of sales 48000 Import duties 2000 50000 Gross Profit 70000 less Stock loss 900 Stock write down XXXX Adjusted Gross Profit 68700 less Other Expenses Rent 3000 Insurance 2400 5400 Net Profit 63300
- 12. © Michael Allison, Trinity Grammar School. Author’s permission required for external use TASK In-class Homework SQ5 X SQ6 X