1 Learning objectives After studying the material in this chapter you will be able to do the following: LO1 Explain the nature, purpose and importance of inventory to an entity. LO2 Distinguish between the perpetual and periodic methods of inventory control. LO3 Distinguish among the different cost formulas used to account for inventory and cost of sales, and understand the impact the different cost formulas have on the amounts reported in the financial statements. LO4Explain the lower of cost and NRV (net realizable value) rule. LO 5 Explain the concept of conservatism. Copyright © 2013 McGraw-Hill Ryerson Limited

2 Lower of Cost and NRV Must report value of inventory at the lower of cost and net realizable value (NRV) NRV is the amount receivable from selling inventory, less any ▫Costs to complete production ▫Costs to complete the sale Copyright © 2013 McGraw-Hill Ryerson Limited LO4

3 Inventory Writedowns A reduction in the carrying amount of inventory - occurs when NRV is less than cost Include in cost of sales with disclosure or as a separate line on the income statement The historical cost, transaction based value of inventory, is replaced with NRV ▫Consistency lost ▫Conservatism gained Copyright © 2013 McGraw-Hill Ryerson Limited LO4

4 Reasons for Writedowns Examples include: Technological change Damaged goods Fluctuation in commodity markets Obsolete items Copyright © 2013 McGraw-Hill Ryerson Limited LO4

5 Reversal of Writedowns Reversal required where in NRV increases in a subsequent period, if still on hand Inventory previously written down is written back up to its original cost Copyright © 2013 McGraw-Hill Ryerson Limited LO4

6 Conservatism/Prudence Requires caution in exercising accounting judgements to ensure ▫Assets, revenues, net income are not overstated ▫Liabilities and expenses are not understated Conservative choices today can result in opposite effects in later periods Copyright © 2013 McGraw-Hill Ryerson Limited LO4