So we take closing stock as 12 instead of 15, so the gross profit could reduce.

Question: when next year this closing stock becomes opening stock, would the value remain the same : 12 , or change back to its cost price : 15 ? And why.

We keep the value at $12. We can’t carry forward one value and then bring it forward at a different value!!

Even if we could, think about it. We are going to sell it for $12. If we valued the inventory next year at $15 then when it is sold we would have a loss on it next year of $3. But we have already taken the loss this year because this years profit reduces by $3. We don’t want to show the loss in both years!!!

The whole point of this rule is that we take the loss as soon as we identify it, but only take profits when they are actually made.

Hi sir, I dont understand the logic behind calculating the cost at the lower value.

Suppose desk cost $10, and I see it is damaged and thus NRV would be $8.
(NRV is basically expected Net Profit correct ? So why give it such a complicated name?)

I expect to sell it at a loss of $2. But if I record cost of current asset, ie the inventory @ the lower value which is $8, then within the SOPL I would be lying to myself that I did not make a loss. I would record to myself as no profit no loss ($8-$8=0). Therefore I would find it logical to always value at the higher amount, for precautions – to make sure we are not overlooking any losses.

The lower of the two values would not make sense to me in SOPL, but only in SOFP if I want to sell my company – and not cheat the investor that the worth of my inventory is more whereas it is actually less (depreciation due to damage to goods).

Please explain to me sir the true Logic. Greatly appreciated. The rest you wonderfully explained – and I was until now from my paid course, not understanding the difference between cost and NRV, until you made it simple ! Thanks.

NRV is not the expected net profit. It is the expected selling price less any expected future costs. (The name is very sensible – realisable value means sales value, and it is net because it is after subtracting any future expenses (such as selling expenses))

If we reduce the value of the inventory (because the NRV is lower than the cost), this makes the cost of goods sold higher and the profit lower.
That is perfectly sensible 🙂

So it would only be called Net profit if we substract sales value with both the future expected cost and the past cost combined ?

Sir, I thought value means cost. Can you please demonstrate with an example how if value of inventory is recorded low, thee cost of goods thus becomes higher higher ?

Yes – then it would be net profit, but that is not relevant.

Think about it. The cost of sales is opening inventory plus purchases less closing inventory. If the value of closing inventory is lower, then a lower amount is subtracted when calculating the cost of sales, and therefore the cost of sales is higher.

Profit is sales less cost of sales. If the cost of sales is higher then the profit is lower.

I do actually stress this in the lectures when I compare the FIFO and average methods of valuing inventory.

Hello Sir, I think that you made an error in example 4 for B.
We should value inventory at cost not realizable value. But you multiply it by $11.
Correct me if I am wrong.

No – what I have done is correct, because for for A and C the cost is lower than the net realisable value, and therefore the inventory is valued at cost.

Hello sir in doing example 4 i think you made a mis error in A and C where you multiplied with cost per unit with unit to get the value if i am wrong please correct me thank you

Nduati@254 says

Excuse me sir, in example 4(b), when calculating the total value why did use the NRV value (11) instead of cost per unit (12)?

John Moffat says

Because the accounting standard says that we must value at the lower of the cost and the NRV, as I do explain in the lectures.

Asif110 says

We value at the lower of the two – cost or NRV.

Suppose cost = 15 , NRV 12.

So we take closing stock as 12 instead of 15, so the gross profit could reduce.

Question: when next year this closing stock becomes opening stock, would the value remain the same : 12 , or change back to its cost price : 15 ? And why.

John Moffat says

We keep the value at $12. We can’t carry forward one value and then bring it forward at a different value!!

Even if we could, think about it. We are going to sell it for $12. If we valued the inventory next year at $15 then when it is sold we would have a loss on it next year of $3. But we have already taken the loss this year because this years profit reduces by $3. We don’t want to show the loss in both years!!!

The whole point of this rule is that we take the loss as soon as we identify it, but only take profits when they are actually made.

Asif110 says

You are an amazing teacher, good bye.

Asif110 says

Hi sir, I dont understand the logic behind calculating the cost at the lower value.

Suppose desk cost $10, and I see it is damaged and thus NRV would be $8.

(NRV is basically expected Net Profit correct ? So why give it such a complicated name?)

I expect to sell it at a loss of $2. But if I record cost of current asset, ie the inventory @ the lower value which is $8, then within the SOPL I would be lying to myself that I did not make a loss. I would record to myself as no profit no loss ($8-$8=0). Therefore I would find it logical to always value at the higher amount, for precautions – to make sure we are not overlooking any losses.

The lower of the two values would not make sense to me in SOPL, but only in SOFP if I want to sell my company – and not cheat the investor that the worth of my inventory is more whereas it is actually less (depreciation due to damage to goods).

Please explain to me sir the true Logic. Greatly appreciated. The rest you wonderfully explained – and I was until now from my paid course, not understanding the difference between cost and NRV, until you made it simple ! Thanks.

John Moffat says

NRV is not the expected net profit. It is the expected selling price less any expected future costs. (The name is very sensible – realisable value means sales value, and it is net because it is after subtracting any future expenses (such as selling expenses))

If we reduce the value of the inventory (because the NRV is lower than the cost), this makes the cost of goods sold higher and the profit lower.

That is perfectly sensible 🙂

Asif110 says

So it would only be called Net profit if we substract sales value with both the future expected cost and the past cost combined ?

Sir, I thought value means cost. Can you please demonstrate with an example how if value of inventory is recorded low, thee cost of goods thus becomes higher higher ?

John Moffat says

Yes – then it would be net profit, but that is not relevant.

Think about it. The cost of sales is opening inventory plus purchases less closing inventory. If the value of closing inventory is lower, then a lower amount is subtracted when calculating the cost of sales, and therefore the cost of sales is higher.

Profit is sales less cost of sales. If the cost of sales is higher then the profit is lower.

I do actually stress this in the lectures when I compare the FIFO and average methods of valuing inventory.

tkhue3296 says

Thanks sir ,

one more cleared .

gernot says

Hello Sir, I think that you made an error in example 4 for B.

We should value inventory at cost not realizable value. But you multiply it by $11.

Correct me if I am wrong.

John Moffat says

No – there is no error.

We value at the lower of cost and net realisable value. The NRV is $11, which is lower than the cost.

John Moffat says

No – what I have done is correct, because for for A and C the cost is lower than the net realisable value, and therefore the inventory is valued at cost.

hilamu says

thank you sir for the clarification.

John Moffat says

You are welcome 🙂

hilamu says

Hello sir in doing example 4 i think you made a mis error in A and C where you multiplied with cost per unit with unit to get the value if i am wrong please correct me thank you