If the price of goods falls, at what value is the inventory in the warehouse shown in the balance sheet?

At the end of December, Sherzod, the owner of the "Qadam" shoe shop, walked around the warehouse. Winter boots are selling well. But the sandals left over from last summer can now only be sold at a discount. In one corner stands a box of sneakers that got wet when the roof leaked.

Chief accountant Nodira summed up the problem in one sentence: "In the balance sheet all these goods are carried at the price we bought them for. But part of them can no longer be sold at that price."

What is the rule?

Under paragraph 12 of NAS No. 4, inventories are measured at the lower of two values at the balance sheet date: - cost (purchase price or production cost); - net realizable value.

Net realizable value (paragraph 3) is the current value after deducting the estimated costs of bringing the inventory into a condition for use according to its purpose and of selling it. In practice it is calculated like this:

Net realizable value = expected selling price − cost of preparing for sale − selling costs

When is a write-down needed?

Paragraph 53 lists four cases. The value of inventory is written down if: - the inventory is damaged; - it is wholly or partly obsolete; - its net realizable value has fallen; - the costs of completing, making the goods presentable or selling them have increased.

The same paragraph contains one more important point: a write-down is applied especially when inventory has built up excessively and is turning over slowly. The aim is simple: goods should not look more expensive in the balance sheet than the amount expected from them.

The calculation at the "Qadam" shop

Amounts in soum, hypothetical.

The 20 000 soum for the sneakers: 15 000 for cleaning and drying, 5 000 selling costs.

Total at cost: 12 000 000 + 7 500 000 + 2 500 000 = 22 000 000 soum. The balance sheet shows 20 300 000 soum. The write-down is 1 700 000 soum: - sandals: (150 000 − 130 000) × 50 = 1 000 000 soum; - sneakers: (250 000 − 180 000) × 10 = 700 000 soum.

The boots stay at cost. Their net realizable value is higher, but in the balance sheet they are not shown above cost.

The most common mistake: throwing everything into one pot

The young accountant Bekzod calculated it differently: he compared total cost with total net realizable value.

Total net realizable value: 40 × 360 000 + 50 × 130 000 + 10 × 180 000 = 22 700 000 soum. With this method, the profit expected from the boots "covers up" the loss on the sandals and sneakers. Paragraph 49, however, requires net realizable value to be determined for each unit (type) of inventory. Under paragraph 54, too, a write-down is usually made item by item. Related inventories that meet the conditions listed in that paragraph may be grouped. But inventory is not written down on the basis of a general classification by industry or region.

What can confirm the new price?

Paragraph 52 gives five sources for documenting current value. Which one to use is up to the organization: - price information obtained in writing from manufacturers, their official dealers or commodity exchanges; - if the inventory was purchased in foreign currency, cost information at the purchase date (recalculated with a coefficient derived from the ratio of Central Bank exchange rates); - information on price levels from the relevant government bodies; - prices published in the mass media and specialised literature during the revaluation period; - an appraiser's report.

For the sandals, Sherzod put the supplier's new written price list and the shop's approved discount order into the file.

What about raw materials in production?

Paragraph 55 has a separate rule for workshops. Even if the price of raw materials has fallen, if the finished product made from them is selling at its current value, the raw materials are not written down below cost. The value of materials is reduced only if the price of the finished product is cut because materials have become cheaper and the cost of the finished product exceeds its net realizable value. In that case the most reliable estimate of net realizable value is the cost of buying similar materials.

What happens if the price rises again?

Under paragraph 57, if the net realizable value of written-down inventory later increases, the value is reversed. But the reversal is limited by two things: the new value equals the lower of cost and the revised net realizable value; the reversal does not exceed the amount originally written down.

In spring the sandals were in demand again, their net realizable value rose from 130 000 to 145 000 soum, and 50 pairs are still in the warehouse.

750 000 soum is less than the original write-down of 1 000 000 soum, so it fits within the limit. Under paragraph 60, the reversal amount is shown as a reduction in the cost of inventories sold that was recognised as an expense in that period.

How is it reflected in the accounts?

• Under paragraph 56 of NAS No. 4, the write-down amount is included in the expenses of the reporting period in which it arose.
• The model table in paragraph 154 of NAS No. 21 shows the reduction in value on revaluation of goods as Dt 3190 – Ct 2910–2990.
• For materials, paragraph 87 of NAS No. 21 gives the same rule: the lower of actual cost and net realizable value.

Write down in advance in your accounting policy which entries carry this amount into the expenses of that period. That way you work the same way every year.

Practical tips

• Add a net realizable value check to the year-end stocktaking. Under paragraph 90 of NAS No. 4, a stocktaking is carried out at least once a year, and one of its purposes is to confirm net realizable value. It is enough to add a "condition" column to the count sheet: new, damaged, obsolete.
• Pull a list of "goods not sold for three months" from the sales software. Slow-moving inventory is the first candidate.
• Prepare a separate calculation sheet for each written-down type: cost, expected price, costs, price source.
• Never offset the "surplus" on the boots against the "shortfall" on the sandals.