What is the primary basis for valuing inventory in accounting?
Show model answer
B. Historical cost Inventory is primarily valued at historical cost, which is the price paid to acquire or produce it. However, it must not exceed net realisable value.
Which method is used to calculate the value of inventory when its cost exceeds its net realisable value?
Show model answer
C. Lower of cost and net realisable value When the cost of inventory exceeds its net realisable value, it should be valued at the lower amount to reflect its true worth.
A company has inventory with a cost of £5,000 and a net realisable value of £4,500. What is the correct valuation?
Show model answer
B. £4,500 The inventory should be valued at the lower of cost (£5,000) and net realisable value (£4,500), which is £4,500.
What is the formula to calculate the net realisable value of inventory?
Show model answer
A. Selling price - selling costs Net realisable value is the estimated selling price of inventory minus the estimated costs of completion and selling.
How does overvaluing inventory affect gross profit?
Show model answer
A. It increases gross profit Overvaluing inventory leads to higher cost of sales being carried forward, which artificially inflates gross profit.
What is the impact of undervaluing inventory on the statement of financial position?
Show model answer
B. It understates assets Undervaluing inventory results in lower inventory values on the statement of financial position, understating the business's assets.
A business has inventory with a cost of £3,000 and a net realisable value of £2,800. What journal entry is required to write down the inventory?
Show model answer
A. Debit Inventory £200, Credit Profit for the Year £200 The inventory should be written down by £200 (£3,000 - £2,800), reducing the inventory asset and the profit for the year.
What is the effect of correctly valuing inventory at the lower of cost and net realisable value on equity?
Show model answer
B. It decreases equity Correctly valuing inventory at the lower amount reduces profit, which in turn decreases equity.
Which of the following is a consequence of undervaluing inventory?
Show model answer
D. Understatement of assets Undervaluing inventory leads to lower asset values on the statement of financial position.
How does the valuation of inventory at the lower of cost and net realisable value affect the current ratio?
Show model answer
B. It decreases the current ratio Valuing inventory at a lower amount reduces current assets, which decreases the current ratio (current assets / current liabilities).
What is the purpose of valuing inventory at net realisable value?
Show model answer
B. To reflect the true worth of inventory Valuing inventory at net realisable value ensures that the financial statements present a realistic picture of the business's financial position.
Which of the following errors would result from not applying the lower of cost and net realisable value rule?
Show model answer
A. Overstatement of profit Not applying the lower of cost and net realisable value rule can lead to overstating profit by carrying inventory at an amount higher than its true value.
What is the impact of overvaluing inventory on the statement of financial position?
Show model answer
C. It overstates assets Overvaluing inventory results in higher inventory values on the statement of financial position, overstating the business's assets.
How does the valuation of inventory affect the calculation of gross profit margin?
Show model answer
D. It can either increase or decrease gross profit margin Valuing inventory at the lower of cost and net realisable value can either increase or decrease gross profit margin, depending on whether the inventory is written down or not.
What is the correct treatment for inventory that has been damaged and can only be sold for £1,000, originally costing £1,500?
Show model answer
C. Value at £1,000 The damaged inventory should be valued at its net realisable value of £1,000, which is lower than its original cost of £1,500.