ACCA Audit and Assurance (F8) Practice Exam

What is the valuation method used for inventory?

1. Fair value measurement

2. Historical cost only

3. Lower of cost or Net Realisable Value

4. Market value only

The correct answer is: Lower of cost or Net Realisable Value

The correct answer is based on the principle that inventory should be valued at the lower of its cost or net realizable value (NRV). This method aligns with the prudence concept in accounting, which emphasizes not overstating assets and ensuring that potential losses are recognized as soon as they are identified. Cost refers to the purchase price plus any additional costs necessary to bring the inventory to its current condition and location, such as shipping or handling fees. Net realizable value is the estimated future selling price of the inventory less any costs expected to be incurred in selling it. By utilizing this method, companies are required to write down the value of their inventory if the market price falls below the cost, thus ensuring that the financial statements reflect a conservative valuation of assets. Other methods, such as fair value measurement or historical cost only, do not provide the necessary safeguards against overvaluation in changing market conditions. Additionally, focusing solely on market value would ignore the relevant accounting principles that require consideration of costs associated with acquiring inventory. The lower of cost or net realizable value methodology thus strikes a balance between recognizing potential losses while maintaining a direct relationship to the actual costs incurred in acquiring the inventory.