1. In your own words, explain the conservatism principle. How is the conservatism principle applied to...

1. In your own words, explain the conservatism principle. How is the conservatism principle applied to the valuation of merchandise inventory? Why do you think this principle is applied to the valuation of merchandise inventory?

2. In your own words, explain the meaning of consistency? How is the consistency principle applied in the choice of inventory valuation methods? Why do you think this principle is applied to inventory valuation?

Expert Solution

Answer 1: The conservatism principle is the concept stating that the recongnition of liabilities and expenses which are uncertain as soon as possible but recongnise revenue and assets when there is certainty. In other words we can say that it is a like prudence which allows recording of future losses but not for future gains.

As conservatism priciple is the reason behind valuation at lower of cost or Net Realisable Value/Market Value which states that inventory should be recorded at lower of the either two i.e. Market Price/Cost.

I think this priciple should applied to valuation of inventory to save the tax because it results in lower taxable income and therefore lower tax receipts.

Answer 2: The consistency concept is stating that we should maintain the consistency in applying accounting principles, practices and procedures in future accounting years what we followed in earlier year(s) because it helps to keep the financial statements comparable. We should only change and adopt the change in above principles if the same will improve the presentation/disclosures of financial statements.

The consistency principle applied when we choose among the different methods available for inventory valuation. If we change the inventory valuation method we have to restate prior years financial statements using the same inventory valuation method. For example if we are following the FIFO in first and second year and change the method from FIFO to LIFO in third year that affects the financials and if in fourth year i want to boorow some money and want to change the method again from LIFO to FIFO its not permitted and that is how i think consistency principle works.

ekkarill92 answered 2 years ago

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