Accounting – 4.5 Valuation of inventory | e-Consult
4.5 Valuation of inventory (1 questions)
Login to see all questions.
Click on a question to view the answer
Potential Difficulties in Applying LCNRV:
While LCNRV is a sound accounting principle, applying it can present certain difficulties:
- Estimating NRV: Accurately estimating the net realisable value can be challenging. It requires forecasting future selling prices, considering market trends, and assessing potential obsolescence. Inaccurate estimates can lead to over- or under-valuation of inventory.
- Subjectivity: Determining the costs of completion and disposal can be subjective. Estimates of these costs may be based on assumptions that prove incorrect.
- Impact on Profitability: Writing down inventory to NRV can reduce reported profits in the current period. This can be perceived negatively by investors and stakeholders, even though it reflects a more realistic valuation of assets.
- Inventory with no resale value: If inventory has no resale value, the LCNRV method may not be applicable. In such cases, the inventory may need to be written off completely.
Examples:
- Example 1 (Obsolescence): A company produces electronic goods. A new, more advanced model is released, making the existing stock of older models obsolete. Estimating the NRV of these obsolete goods can be difficult, as there may be no market for them. The company may need to consult with industry experts to assess the potential resale value.
- Example 2 (Damage): A company imports fragile goods. During transportation, a significant portion of the shipment is damaged. Determining the NRV requires estimating the value of the undamaged goods and the costs associated with repairing or disposing of the damaged goods. This estimation can be complex and time-consuming.