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Hi sir for December 2014 exam, question 2) , the audit risk stating the following,
“Eagle Heating Co (Eagle) has decreased the selling price of products significantly since September 2014 and there are increased levels of inventory expected at the year end.
It is possible that the selling price may have fallen so that the net realisable value (NRV) of inventory is below cost. IAS 2 Inventory requires inventory to be stated at the lower of cost and NRV. Hence it is possible that inventory is overvalued.”
I don’t understand the explanation. Why would Eagle Co decrease its selling price so that the NRV will be below cost? what’s the purpose ? And how do they know that inventory could be overvalued ? Could you explain sir ?
This is a really easy query. You need to start thinking about it yourself. Think carefully about why might a company might have to set a selling price below an article’s cost?
If the company reduces its selling price, then its NRV will be lower than cost. Which means the year end inventory would be valued at it NRV. This would mean that inventory is understated.
But in the explanation it states that inventory could be overvalued.
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