Inventory Valued At Realizable Value

[Damage or Obsolescence]

Accounting Standard – 2 (Revised) provides: Inventories should be valued at the lower of cost and net realizable value. And the net realizable value has been defined as the “estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.” A simple reading would make it clear that the net realizable value is nothing but expected selling price less expected costs to be incurred to sell or dispose. The historical cost of inventories is compared with the net realizable value and the lower of the two is adopted for the purpose of income statement and the balance sheet. The justification for the adoption of this procedure is to be in those cases where the costs of the inventories may not be recoverable if those inventories are:

(i) Damaged and (ii) they have become wholly or partially obsolete. Thus the rule of lower of cost and net realizable value is applicable to damaged and obsolete items of stock-in-trade. Furthermore, the costs of inventories may also not be recoverable if the estimated costs of completion or the estimated costs necessary to make the sale have increased. It means that when net realizable value is less than the cost, there is bound to be loss on sale and it is considered appropriate by the accountants to recognize it on the ending date of the accounting period without waiting for the actual sale in the next accounting period. It would be misleading to carry forward the full cost of inventories to be matched against the revenues of the next accounting period. The purpose is obviously to measure or calculate the true income of the current accounting period because if a part of the cost has become a loss, it should be matched against the revenues of the year in which the loss occurred. Moreover the practice of writing down inventories below cost to net realizable value is consistent with the view that the asset should not be carried in excess of amounts expected to be realized form their sale or use. In other words, assets must reflect true values rather than inflated one in order to have true and fair view of the financial position. To sum up, the measurement or calculation or calculation of loss will depend on whether the loss is due to damage or obsolescence.

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