Answer to Question #216703 in Economics for qianhe

Question

'FINANCIAL ACCOUNTING 2'

‘The idea that stock should be included in accounts at the lower of historical cost and net realisable value follows the prudence convention but not the consistency convention.’ Required:

(a) Do you agree with the quotation?

(b) Explain, with reasons, whether you think this idea (that stocks should be included in accounts at the lower of historical cost and net realisable value) is a useful one. Refer to at least two classes of user of financial accounting reports in your answer.

Answer 1

a) It is not true, as the cost of inventory must include: purchase costs (including taxes, transport, and handling) fewer trade discounts, processing costs (including fixed and variable production overheads), and other costs associated with moving inventory to their current location and condition.

b) Inventories are assets that are held for sale in the ordinary course of business, are in the process of being created for subsequent sale, or are intended to be used in the production of goods or the provision of services.

Reserves must be recognized in the accounts if two common criteria are met:

• The use of the reserves will result in a likely inflow of economic benefits;
• The initial value of these inventories can be estimated reliably.

Inventories are an asset, that is, for their recognition, it is necessary that control over this asset is completely transferred to the acquiring company.