Inventory Valuation: Methods, NRV, and Impact on Profit Questions

Question 1

What is FIFO?

Accepted Answer

FIFO is a method in which earliest purchases are assumed to be issued or sold first.

Question 2

What is LIFO?

Accepted Answer

LIFO is a method in which latest purchases are assumed to be issued or sold first.

Question 3

Define NRV.

Accepted Answer

Net realisable value (NRV) is the estimated selling price of inventory less costs of completion and selling expenses.

Question 4

Define inventory.

Accepted Answer

Inventory is the stock of goods held for sale or for use in production in the normal course of business.

Question 5

What is closing stock?

Accepted Answer

Closing stock is the value of unsold goods remaining at the end of the accounting period.

Question 6

State the general rule of valuation of inventory.

Accepted Answer

Inventory is generally valued at the lower of cost or net realisable value, whichever is lower.

Question 7

Explain objectives of inventory valuation.

Accepted Answer

Inventory valuation is important to determine the correct cost of goods sold and thus correct gross profit for the period. It also helps to show the true financial position because closing stock is a current asset in the balance sheet. Further, it ensures application of prudence and consistency so that profits and assets are not overstated and financial statements remain comparable.

Question 8

Explain the concept of cost and NRV in inventory valuation.

Accepted Answer

Cost of inventory includes purchase price plus directly attributable costs such as carriage inward and non-refundable taxes, after deducting trade discounts. NRV is the estimated selling price less costs of completion and selling expenses. Inventory is valued at lower of cost or NRV to follow prudence and to avoid showing stock at a value higher than what can be realised from sale.

Question 9

Differentiate between FIFO and LIFO.

Accepted Answer

FIFO assumes earliest purchases are issued first, so closing stock reflects the latest purchase prices. LIFO assumes latest purchases are issued first, so closing stock reflects older prices. In periods of rising prices, FIFO generally gives higher closing stock and higher profits, whereas LIFO gives lower closing stock and lower profits.

Question 10

Explain weighted average method with formula.

Accepted Answer

Weighted average method values issues and closing stock at an average cost per unit computed as: Average cost per unit = Total cost of goods available for sale ÷ Total units available. This method smoothens price fluctuations and provides moderate valuation compared to FIFO and LIFO.

Question 11

Explain impact of closing stock valuation on profit.

Accepted Answer

Closing stock directly affects cost of goods sold (COGS): COGS = Opening stock + Purchases + Direct expenses − Closing stock. If closing stock is higher, COGS becomes lower and gross profit increases; if closing stock is lower, COGS increases and profit decreases. Hence, wrong stock valuation leads to incorrect profit and also misstates current assets in the balance sheet.

Question 12

Write a short note on consistency in inventory valuation.

Accepted Answer

Consistency means the same inventory valuation method (FIFO/LIFO/average) should be applied from year to year so that profits and stock values are comparable. Frequent changes can distort profit trends. If a change is necessary, it should be disclosed with its effect on profit and stock valuation.

Question 13

Explain methods of inventory valuation and compare FIFO, LIFO and weighted average.

Accepted Answer

Inventory valuation methods decide the cost assigned to issues and the value of closing stock, thereby affecting gross profit.

**FIFO (First in First out):** earliest purchases are issued first; closing stock reflects recent costs. In rising prices, FIFO generally gives lower COGS and higher profit, and closing stock value is higher.

**LIFO (Last in First out):** latest purchases are issued first; closing stock reflects older costs. In rising prices, LIFO generally gives higher COGS and lower profit, and closing stock value is lower.

**Weighted Average:** average cost per unit is computed as total cost of goods available divided by total units available. Issues and closing stock are valued at this average rate, giving a moderate effect and reducing the impact of price fluctuations.

Thus, FIFO, LIFO and weighted average differ in issue assumptions and they significantly influence reported profit and closing stock.

Question 14

Explain valuation of inventory at lower of cost or NRV and its significance.

Accepted Answer

Inventory is valued at the lower of cost or net realisable value (NRV) to follow the prudence principle and to avoid overstatement of assets and profits. Cost represents the expenditure incurred to bring inventory to its present condition. NRV is the estimated selling price less costs of completion and selling expenses.

If NRV falls below cost due to damage, obsolescence or fall in market price, inventory is written down to NRV and the loss is recognised in the current period. This ensures that financial statements show stock at an amount that is expected to be realised and that profits are not inflated.

Question 15

Explain how inventory valuation affects trading account and balance sheet.

Accepted Answer

Closing stock is credited in Trading Account and shown as a current asset in the Balance Sheet. Since COGS is calculated by deducting closing stock from the total of opening stock, purchases and direct expenses, any change in closing stock changes COGS and gross profit. Higher closing stock reduces COGS and increases gross profit; lower closing stock increases COGS and reduces gross profit. Therefore, correct inventory valuation is essential for true gross profit in Trading Account and true current assets in Balance Sheet.

Inventory Valuation: Methods, NRV, and Impact on Profit

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