Why should inventory be valued at lower cost?

Understanding Lower of Cost or Market Method The lower of cost or market method lets companies record losses by writing down the value of the affected inventory items. The amount by which the inventory item was written down is recorded under cost of goods sold on the balance sheet.

Should inventory be valued at the lower of standard cost or market?

The lower of cost or market rule states that a business must record the cost of inventory at whichever cost is lower – the original cost or its current market price. This situation typically arises when inventory has deteriorated, or has become obsolete, or market prices have declined.

Why are inventories stated at lower of cost and net realizable value?

Obsolescence, over supply, defects, major price declines, and similar problems can contribute to uncertainty about the “realization” (conversion to cash) for inventory items. Therefore, accountants evaluate inventory and employ lower of cost or net realizable value considerations.

Why is inventory valuation important for a business?

The way a company values its inventory directly affects its cost of goods sold (COGS), gross income and the monetary value of inventory remaining at the end of each period. Therefore, inventory valuation affects the profitability of a company and its potential value, as presented in its financial statements.

When inventory cost is lower than NRV inventory should be reported at?

net realizable value
A manufacturer’s inventory would be at its cost to produce the items (the cost of direct materials, direct labor, and manufacturing overhead). However, if the net realizable value (NRV) of the inventory is less than the cost, the NRV will usually need to be reported on the balance sheet instead of the cost.

Why is inventory valued at cost?

The method for valuing inventory depends on how the stock is tracked by the business over time. A business must value inventory at cost. Since inventory is constantly being sold and restocked and its price is continually changing, the business must make a cost flow assumption that it will use frequently.

Why inventory should not be valued at selling price?

Generally, items in inventory are valued at their cost—not their selling prices—because of the cost principle. Another reason for not valuing items in inventory at their selling prices is that inventory items cannot be sold without a sales effort.

Why did the value of your inventory change?

Your inventory value can also increase if the supply of your product in the market decreases while demand remains relatively steady. Commodities are one example; if you have a warehouse full of coffee and weather ruins the coffee crop, the value of your inventory will increase with the market price.

Why are inventories included in the computation of net income?

2. Why are inventories included in the computation of net income? To determine cost of goods sold.