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Valuing Stocks

The basic rule is that "stocks are valued at the lower of cost or net realisable value." Sometimes I get confused when the scenario is asked in a different way. Here are two scenarios that I want you to attempt:

Value the following items of stock:

  1. Material costing $12,000 bought for processing and assembly for a profitable special order. Since buying these items, the cost price has fallen to $ 10,000.
  2. Equipment constructed for a customer for an agreed price of $ 18,000. This has recently been completed at a cost of $ 16,800. It has now been discovered that, in order to meet certain regulations, conversion with an extra cost $ 4,200 will be required. The customer has accepted partial responsibility and agreed to meet half the extra cost.
What are your answers ? I am sure that you will get it right. Respond as comments on the blog.

Answer 1 : Value of Material is _____

Answer 2: Value of Equipment is _______

Give reasons for your answer..


Santosh Puthran


In the first case it is a special order it is assumed the price is fixed then:
$12000 is sunk.The value should be treated as $12000 and cost absorbed in the price fixed.
If the price is yet to be fixed then there is range for absorbtion to $2000 depending on other factors including buyers capacity to bargain in the given condition.
But this is for pricing purpose however accountal will have to be on full sunk cost.
In the second case the incidental cost is $4200 which means the cost of equipment now stands at $21000/-
Customer will pay now $20100/-a loss of $900/-
Anonymous said…
Point 2
It should be valued at $16800+2100 =18900
Because 16800 is cost of equipment and 2100 is accepted liability.
For valuation purpose one should not take selling price(i.e. agreed price).

Reference to point 1,

Raw material is always valued at cost price since it is purchased for own consumption and is not for sale.
( also RM is always valued at moving average price-normally, thus any incerease or decrease in cost gets averaged out)

In case intention is to sell the the raw material then the market rate or cost price whichever is lower as to be selected.

Anonymous said…
For Case no.1, the valuation of the stock is on cost basis as it is rawmaterial (here cost cost will be generally at weighted moving average).

For case no.2, the value of the stock would be $16800+$2100(extra cost partial amt)or the market price whichever is lesser, since it is finished good (conservatism principle)

In the first case the special order is said to be profitable which means the stock is moving.Only thing one should determine is whether the cost of the order should comedown because of reduction of rawmaterial cost by $2000/- in the market.This situation is subjective and negotiable for sustenance.Ideally full cost recovery is a must but the situation demand a reassessment then it should be leveraged upto $2000.
In the second case Incremental cost arose after the project cost is sunk.What the Buyer has agreed to is to share 50% which translates to 2100/- additional revenue but what u incurr is full 4200/- which means the cost equipment remains unchanged (inclusive of increment)again we are not valuing stock here we are valuing Cost of sale which is fully sunk to create an equipment.
Anonymous said…
Amogh Paranjape:

for valuing hte Material as on the balance Sheet Date the valuation should be $10000 Less the Profit of the supplier. Or say at $10000
Reason is - at the date of valuation cost or net realisable price is to be considered. Earlier purhcases cost now is irrrelavent. B/S should reflect its true & Fair view as on the date of it.

Supplier has now quoted hte new sellingprice of Rs. $10000 which includes his profit , therefore in our case when we go for its realisable price profit of the supplier will not be realised.
Anonymous said…
Amogh Paranjape
In second Case the Equipment should be valued at Rs. 16800 being the actual cost price.
earlier aggreed price of 18000 may be including the profit & 16800 may be cost of finished goods.
What is now cost of upgardation in future is not yet spent by the seller. it is therefore irrrelavent.
santoshputhran said…
Thanks for so many responses. It has already turned out to be 6 accountants having 7 opinions. The solution that is available from where I picked this problem is as follows:

Solution 1: Value at $12000. $10,000 is irrelevant. The rule is lower of cost or net relisable value. Since the materials will be processed before the sale there is no reason to believe that net realisable value will be below cost.

Solution 2: Value at net realisable value ie. $ 15900, as this is below cost (NRV = contract price of $ 18,000 less the company's share of modification cost, $ 2100)

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