Question

GAAP allows us to reduce inventory value decline to market value and recognize the loss. However, recognition of inventory value are not allowed.

Discuss your thoughts on this seemingly inequitable treatment.

Where else have you seen revaluing to market values?

Was the revaluation allowed in both directions?

Answer 1

Under GAAP, inventory is recognised at cost or market value whichever is lower.

This allows us to reduce the value of inventory in books if its market value reduces below the cost of inventory. The differential loss is recognised in P&L account as loss. However, as GAAP asks us to recognise the inventory at lower of the cost or market value, if the market value is more than the cost, it does not allow us to increase the value in books as the cost of inventory is still lower than the market value.

Hence, due to the condition of "whichever is lower" only when the market value is lower than the cost, is the value of inventory reduced and is not increased when the market value is more than the cost. This is rightly so as the conservative approach does not allow us to book the profits till actual sale if the market value of the inventory increases above cost, but it asks us book the losses if the market value decreases below the cost.

Revaluation to market values is also done for Investments. But here, the revaluation is done both sides/ directions, that is, if the market value increases we book the profits and if it decreases we book the losses. This is done because investments are made for earning income besides normal course of earnings, and hence the investments should be revalued at each closing date to calculate the actual profits or losses resulting from the investments. Profits or losses are booked in P&L account.