U3, AOS 1 - KK11 - Cost vs. NRV Flashcards
Q: Define the Lower of Cost or Net Realisable Value (NRV) rule in accounting.
A: The Lower of Cost or NRV rule states that inventory must be valued at the lower of its historical cost or its net realisable value to ensure assets are not overstated
Q: What is the formula for Net Realisable Value (NRV)?
A: NRV = Estimated Selling Price – Direct Selling Expenses
Q: What are some reasons why the NRV of inventory might fall below its cost price?
A: Obsolescence, damage, a decrease in market price, competitor pressure or product falls out of fashion
Q: If a business purchases a product for $50 per unit but the estimated selling price drops to $45, with selling costs of $3 per unit, what is the NRV?
A: NRV = $45 - $3 = $42
Q: A retailer has 100 units of an item costing $10 each. If NRV falls to $8 per unit, how much should inventory be reported at?
A: 100 × $8 = $800 (instead of $1,000 at cost).
Q: What financial statements are affected when inventory is written down to NRV?
A: The Balance Sheet (reducing inventory value) and the Income Statement (recording an inventory write-down as an expense).
Q: True or False: Applying the Lower of Cost or NRV rule leads to higher net profit.
A: False. It lowers net profit by recognising a loss on inventory.
Q: The cost of a product is $20 per unit. The estimated selling price is $25, and selling expenses are $6 per unit. Should the inventory be reported at cost or NRV?
A: NRV = $25 - $6 = $19 (Lower than cost of $20, so inventory is reported at NRV of $19).
Q: What qualitative characteristic supports the use of Lower of Cost or NRV?
A: Faithful Representation – Ensuring financial reports reflect reality by avoiding overstatement of assets.
Q: What journal entry is required when inventory is written down?
A:
Dr Inventory Write-Down (Expense)
Cr Inventory
Q: True or False: The Lower of Cost or NRV rule applies only to perishable goods.
A: False. It applies to all inventory types, including technological goods, fashion items, and raw materials.
Q: A business has 200 units of an item. Cost is $15 per unit, NRV is $12 per unit. Calculate the total inventory write-down.
A: (Cost - NRV) × Quantity = ($15 - $12) × 200 = $600 write-down.
Q: How does the Lower of Cost or NRV rule affect the Accounting Equation?
A: Assets decrease (Inventory ↓), Equity decreases (Net Profit ↓ due to the write-down expense), and Liabilities remain unchanged.
