The Basis of the Valuation of Inventory (Cambridge (CIE) O Level Accounting)
Revision Note
Written by: Dan Finlay
Reviewed by: Lucy Kirkham
Cost & Net Realisable Value
What is the cost and net realisable value of inventory?
The cost of inventory is the total cost to the business of obtaining goods
The purchase cost of the goods
Plus the cost for carriage inwards
The net realisable value (NRV) of inventory is the net amount the business is likely to receive when selling the goods
The selling price of the inventory
Minus any selling expenses
Such as the cost of repairing damaged goods
What is the basis for the valuation of inventory?
Inventory is valued at the lower value between:
The cost
The net realisable value
This method of valuation complies with the accounting principle of prudence
The value of the inventory (asset) is not overstated
The profit is not overstated
For most inventory, the cost will be the lower of these values; however, there are some exceptions
Damaged goods might need to be repaired before they can be sold
Goods that are close to their expiration date might need to be sold at a lower price
The business might use lower prices to promote new products
Worked Example
Chen purchased an item of inventory for $15 and paid an extra $3 for delivery charges.
Chen accidentally damages the item. If he spent $8, he could sell it for $24.
What is the value of the item of inventory?
Answer
Find the total cost of the item by adding the delivery charge to the purchase cost
$15 + $3 = $18
Find the net realisable value by subtracting the repair cost from the selling price
$24 - $8 = $16
Inventory is valued at the lower value between cost and net realisable value.
The inventory is valued at $16
Inventory Valuation Statements
What is an inventory valuation statement?
An inventory valuation statement shows the total valuation for the inventory of a business
These are useful when a business sells different types of goods
There is no fixed format, however, a table is normally used
The statement should show:
The name of each type of good
The cost of each item
The net realisable value of each item
The quantity of each type of goods
The total value of each type of goods
The overall value of the goods
Examiner Tips and Tricks
Use a table structure to make your workings clear to an examiner. This means that you might get follow-through marks if you make an arithmetic mistake but follow the correct process.
Worked Example
Mei is a trader who sells art supplies. Mei provides the following information about her inventory at 29 February 2024.
Item | Number of units | Cost per unit $ | Carriage inwards per unit $ | Selling price per unit $ | Selling expenses per unit $ |
Paintbrushes | 50 | 2 | - | 4 | - |
Packs of Paint | 80 | 25 | 2 | 30 | 1 |
Easels | 5 | 30 | 5 | 40 | 8 |
Calculate the value of the inventory at 29 February 2024.
Answer
Find the total cost per unit by adding together the cost per unit and the carriage inwards per unit
Find the net realisable value per unit by subtracting the selling expenses per unit from the selling price per unit
Value each unit at the lower of the cost and the net realisable value
Multiply the value per unit by the number of units to find the total value for each item
Add together the total values for each item.
Item | Number of units | Cost $ | Net realisable value $ | Value per unit $ | Valuation $ |
Paintbrushes | 50 | 2 | 4 | 2 | 50 ✕ 2 = 100 |
Packs of Paint | 80 | 25 + 2 = 27 | 30 - 1 = 29 | 27 | 80 ✕ 27 = 2 160 |
Easels | 5 | 30 + 5 = 35 | 40 - 8 = 32 | 32 | 5✕ 32 = 160 |
Total | 2 420 |
The total valuation of the inventory is $2 420.
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