Question

Illustrate with an example how prudence concept/assumption may be applied to accounting for inventory.

Answer 1

Prudence Concept :- Prudence concepts is also known as convertism concept. Under this concept , the income, Assets should not be overstated ( overcharged) and liabilities, expenses should not be understated ( under charged) . The provision should be made for certain, justifying and estimated expenses/ losses.

Application of prudence concept on accounting of inventory. :-

According to this concept , inventory ( assets) should be recorded on Original cost or Net realizable value whichever is low . no obsolete of part inventory should be remained in balance.

Example:- suppose the original cost of inventory = $ 2000

Current Estimated Market Value of Closing = $ 1600

Value of inventory will be recorded on $ 1600 because it is lower in above [ Original cost and Net realizable value ( Market value) ] .