Valuation of Inventory
This lesson covers the rules for valuing inventory. Students will learn how to calculate and record impairment loss on inventory in the journal, and the impact of incorrect valuation on profit and owner’s equity . The lesson also explains how to record inventory losses that are compensated by insurance.
Related Lessons:
Valuing Inventory & Impairment Loss on Inventory
Inventory is valued at the lower of cost or net realisable value where net realisable value is the estimated selling price less all cost required to make the sale.
Impairment loss on inventory is the estimated amount of inventory lost when net realisable value is below the cost of inventory.
Example:
Cost of inventory is $2,000
Net realisable value of inventory is $1,600
Impairment loss on inventory is 2,000 – 1,600 = $400
In the Statement of financial performance, expense increase by $400.
In the Statement of financial position, inventory decrease by $400.
Cr Inventory
Impairment loss on inventory is treated as an expense because the business suffers a loss in value. Therefore, the impairment loss on inventory account is closed as an expense account.
Dr Income summary
Cr Impairment loss on inventory
Effect of Incorrect Valuation
When a business does not write down its inventory when net realisable value is lower than cost, expense will be understated, which leads to an overstatement on profit, asset and owner’s equity.
Inventory Loss Compensated by Insurance
When the business purchase insurance for its inventory, damages to inventory that are compensated by the insurance is recorded as follows:
When insurance payment is received in the current accounting period
Dr Cash at bank
Cr Inventory
When insurance payment is received in the next accounting period
Dr Insurance receivable
Cr Inventory
When insurance receivable is received in the next accounting period
Dr Cash at bank
Cr Insurance receivable