IGCSE Accounting — Inventory Valuation: Notes, Practice Questions & Worked Solutions

IGCSE Accounting 0452 · Section 4: Accounting Procedures

Inventory Valuation

Closing inventory is valued using one simple rule of prudence: never overstate what it’s really worth.

1. The Lower of Cost and Net Realisable Value

Inventory value = the LOWER of cost and net realisable value (NRV)

Net realisable value = the expected selling price, minus any further costs needed to complete or sell the item. This follows the prudence concept — never anticipate profits, but do provide for expected losses.

Worked example — comparing cost and NRV An item of inventory cost $500. It is expected to sell for $600, but requires a further $150 of processing and selling costs. Calculate the value at which this inventory should be shown.
NRV = 600 − 150 = $450. Since NRV ($450) is lower than cost ($500), the inventory is valued at $450.

2. Effect of Incorrect Inventory Valuation

Closing inventory appears in both the statement of profit or loss (reducing cost of sales) and the statement of financial position (as a current asset). If closing inventory is overstated:

Cost of sales is understated → gross profit is overstated
Profit for the year is overstated
Equity (capital) is overstated
Current assets are overstated

If closing inventory is understated, every one of these effects is reversed.

Common mistakes to watch for

Valuing inventory at selling price rather than the lower of cost and NRV — this would recognise profit before the sale actually happens, breaking the prudence concept.
Forgetting that NRV isn’t just the selling price — it’s the selling price MINUS any further costs to complete or sell the item.
Applying the lower-of-cost-and-NRV rule to the inventory total as a whole, rather than comparing cost and NRV item by item (or category by category).

Key Vocabulary Recap

Net realisable value (NRV) — expected selling price minus costs to complete/sell

Prudence concept — don’t anticipate profits, but do provide for expected losses

Syllabus Reference

This note covers IGCSE Accounting 0452 Section 4, Inventory: valuing inventory at the lower of cost and net realisable value, inventory valuation calculations, and the effect of incorrect inventory valuation on gross profit, profit for the year, equity, and assets.

Practice questions

IGCSE Accounting 0452 · Section 4: Inventory Valuation — Practice Question Bank (no answers)

Inventory Valuation — Practice

Covers: the lower-of-cost-and-NRV rule, and effects of misvaluation. 10 questions.

State the rule used to value closing inventory.

Define net realisable value.

An item of inventory cost $500. It is expected to sell for $600, but requires a further $150 of processing costs. Calculate the value at which this item should be shown in the accounts.

An item of inventory cost $300. It is expected to sell for $450, with no further costs to sell. Calculate the value at which this item should be shown in the accounts.

Explain why inventory is not valued at its expected selling price.

Explain the effect of overstating closing inventory on gross profit for the year.

Explain the effect of overstating closing inventory on the statement of financial position.

Explain the effect of understating closing inventory on profit for the year.

Explain which accounting concept underlies the lower-of-cost-and-NRV rule.

Q10

An item of inventory cost $800. Due to damage, it can now only be sold for $500, after $50 of repair costs. Calculate the value at which this item should be shown in the accounts.

Worked solutions

Show worked solutions

IGCSE Accounting 0452 · Section 4: Inventory Valuation — Solutions

Inventory Valuation — Practice: Solutions

Rule for valuing closing inventory.

✓Inventory is valued at the lower of cost and net realisable value.

Define net realisable value.

✓Net realisable value is the expected selling price of an item, minus any further costs needed to complete or sell it.

Cost $500, sells $600, processing $150.

NRV = selling price − further costs

600−150=450

✓$450 (NRV is lower than cost of $500)

Cost $300, sells $450, no further costs.

NRV = 450 (no further costs to deduct)

Compare with cost $300

✓$300 (cost is lower than NRV of $450)

Why not value at selling price?

✓Valuing inventory at its expected selling price would recognise profit before the sale has actually happened, breaking the prudence concept (which says not to anticipate profits before they are realised).

Effect of overstating closing inventory on gross profit.

✓Cost of sales is understated (since closing inventory is subtracted in the cost of sales calculation), so gross profit is overstated.

Effect of overstating closing inventory on SOFP.

✓Current assets (inventory) are overstated, and since profit is also overstated, equity (capital) is overstated too.

Effect of understating closing inventory on profit.

✓Cost of sales is overstated (too little inventory is deducted), so gross profit and profit for the year are both understated.

Which concept underlies the rule?

✓The prudence concept — don’t anticipate profits, but do provide for expected losses.

Q10

Cost $800, damaged, sells $500, repair $50.

NRV = 500−50

450

✓$450 (NRV is lower than cost of $800)

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