Question

Both Canadain GAAP for private enterprises and interational financial reporting standards (IFRS) follow the lower of cost and net realizable value rule to value inventory when market price are changing. Explain how this relates to the accounting guideline of conservatism.

Answer 1

Conservatism principle states that the profits should not be overstated while the expenses should not be understated. Reporting of inventories based on lower  of cost and net realizable value rule to value inventory when market price are changing is according to the conservatism concept:

1. Losses from decline in market value at recognized before the sale occurs and the gain on increase in market value above the acquisition cost only on when the sale occurs.

2. Inventories on the balance sheet are reported at a value that is always less than or equal to the acquisition cost but never greater.