Question

Electronics, Inc., is a high-volume, wholesale merchandising company. Most of its inventory turns over four or five times a year. The company has had 50 units of a particular brand of computers on hand for over a year. These computers have not sold and probably will not sell unless they are discounted 60 to 70%. The accountant is carrying them on the books at cost and intends to recognize the loss when they are sold. This way, she can avoid a significant write-down in inventory on the current year’s financial statements. Question 1: Is the accountant correct in her treatment of the inventory? Why or why not? Question 2: Explain what is meant by conservatism and how it ties in with the lower-of-cost-or-market method of accounting for inventory. Question 3: What are some reasons why the inventories of electronic equipment might have to be written down.

Answer 1

1. Accountant is not correct in treatment of inventory by recording it at cost as it is evident from facts that the inventory's realisable value is less in the market. Recording the inventory at cost will unnecessarily inflate the level of inventory which is not realisable.

2. Conservatism method of accounting means where all the probable losses are recognised so that true and fair view of financial statements is evitable. In this particular scenario recording the inventory at lower of cost or market rate will lead to recognition of losses due to fall in prices and business's correct profit and loss can be calculated.

3. Electronic equipments have certain life span of time only. Hence with the passage of time the value of the equipments reduce. So it becomes necessary to reduce the value of the equipment which reduces in the market.

Moreover, the market value of the equipment is not fluctuating. It will tend to reduce only leading to probable losses and thus it becomes necessary to record the equipment at lower of cost or market value.

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