Question

The concept of conservatism has been a strong foundation for CFO's and CPA's in business. Standard practice is for businesses is to reflect inventory values at the lower of cost or market value. This practice may have a business recognize a loss on inventory if the market value declines below what was paid for it, but yet not recognize a gain if the market price raises above what was originally paid. Discuss the argument for this practice from a financial management viewpoint.

Answer 1

Yes we show the value of inventory in financial statements lower of cost or market value it is because of the reason of conservatism in which we do not recognize the unrealized profit but we recognize the unrealized loss.

If the stock market value has gone up as it is obvious that they will be sold at high so profit will come in a normal way as the amount of sales will be increased

For example if the cost of inventory is 10000 and they are sold for 12000 so the profit is 2000.But when the value of inventory has reached to 12000 then we will not recognize the profit of 2000 immediately as it is unrealized profit. Now it is obvious that these will be sold for more value let say at 14000 so now we have recognized profit of 4000, 2000 normal profit and 2000 from increase in the value of inventory.