Golden Crust Bakery holds sacks of imported flour that cost $2,400. Damp in the storeroom has spoiled part of the delivery, and the flour could now be sold ...
Question 1 Report
Golden Crust Bakery holds sacks of imported flour that cost $2,400. Damp in the storeroom has spoiled part of the delivery, and the flour could now be sold for only $1,500. The accountant values it at $1,500 in the accounts to 30 April. State the concept being followed.
Answer Details
The concept being followed is prudence. Inventory is valued at the lower of cost and net realisable value, so that assets and profits are never overstated when the outcome is uncertain.
The flour cost $2,400 but damp has damaged it and it can now be sold for only $1,500. Carrying it at $2,400 would show an asset worth $900 more than the bakery could actually obtain from it, and would leave that $900 loss to fall on a later period. Prudence requires the loss to be recognised as soon as it becomes likely, so the inventory is written down to $1,500 and the $900 reduction is charged against the profit of the year to 30 April.
| $ | |
|---|---|
| Cost | 2,400 |
| Net realisable value | 1,500 |
| Write down charged this year | 900 |
Realisation governs when a profit may be recognised, not when a loss must be; indeed the two work in opposite directions, since prudence recognises the loss before it is realised. Duality is the rule that every transaction has two equal effects, which is true of the write down but says nothing about the amount. Materiality concerns whether the $900 is big enough to matter, which is a separate question from why the value is reduced at all.
Examination point: prudence recognises losses as soon as they are foreseen, while profits wait until they are realised. That asymmetry is the whole point of the concept.
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