Vonelle plc sells computer equipment. The company accountant asks your advice about the following two product lines: 20 tablet computers: original total cost £9,000. They have been unsold for 3 years

Question

Vonelle plc sells computer equipment. The company accountant asks your advice
about the following two product lines:

• 20 tablet computers: original total cost £9,000. They have been unsold for 3 years
and the company sales manager believes that the only way of selling them would be
to upgrade the memory (at a cost of £75 per machine) and sell them at £350 each.

• 10 laptops: originally bought for £400 each to meet a special order, but the customer
went out of business before delivery. Each machine is overprinted with that
customer’s logo. The machines could be sold for an estimated £600 each, but only if
the logo was erased at a cost of £10 per machine.

(a) Explain what is meant by the phrase ‘inventory should be valued at the lower of
cost and net realisable value’.

(b) Explain, with reasons, how each of the two product lines should be accounted for
in the financial summaries of the company.

Accepted Answer

(a) Unsold inventory is never normally valued at selling price, as this assumes – possibly
incorrectly – that they will be sold at a profit. The normal valuation will be based on
cost price (even though this may have to be calculated on a theoretical basis such
as FIFO – First In First Out). Occasionally, inventory has deteriorated, gone out of
fashion or otherwise been devalued so that its anticipated selling price is actually less
than its cost price. Only in these circumstances can the inventory be valued at what
it could be sold for, less any expenses needed to be incurred to make it saleable (also
known as the ‘net realisable value’).

(b) The usual method of inventory valuation is ‘at the lower of cost and net realisable
value’. In the case of the Tablet computers, the selling price is lower than cost, and additional
costs will need to be incurred to sell them. Their valuation will therefore be:

Anticipated selling price 20 × £350 £7,000

Less Upgrade costs 20 × £75 £1,500

£5,500

With regard to the laptops, as the cost is less than the ‘net realisable value’, they
must be valued at cost price: 10 × £400 = £4,000.

Question 3.st.1: Vonelle plc sells computer equipment. The company accountant...

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