Question 4.3: A friend of yours owns a shop selling CDs and posters for th...
A friend of yours owns a shop selling CDs and posters for the 12- to 14-year-old market.
From the following information advise him on the potential problems that may be encountered in the valuation of such items for balance sheet purposes:
(a) greatest hits compilation CDs have sold consistently over the months and cost £5,000 with a retail value of £7,000
(b) sales of specific group CDs, which ceased recording in the previous year, have now dropped off to zero and cost £500 with a total retail value of £700
(c) specific band CDs, which are still constantly recording and selling in the shop every week cost £1,000 with a total retail value of £1,400
(d) specific artist posters are currently not selling at all (although CDs are), and cost £50 with a retail value of £100.
Overview
Inventories are dealt with in IAS2, Inventories, which states that they should be valued at the lower of cost and net realisable value. Retailers can (and do) take the retail value of their inventories (by category) and deduct the gross profit (by category) as an estimate of cost.
(i) This inventory should be valued at £5,000 (cost) as it is selling consistently.
(ii) This inventory should not be in the balance sheet at any value, as it will not generate any cash in the future.
(iii) As in (i) above this inventory can be valued at £1,000 (cost) for balance sheet purposes. As there are more risks associated with holding single artist CDs the inventory levels should be continually reviewed.
(iv) In this situation the selling pattern has changed and the posters have stopped selling. The posters must not appear in the balance sheet as they will not generate any future cash