Dealing with the value of the inventory, auditor should have a clear idea in mind on the difference between allowance for stocks obsolescence and write-down of net realisable value of an inventory. Although the term has not been clearly defined and could be over-lapping, there are clearly two factors need to be considered.
Let's examine the following example.
Company XYZ purchased a product A from its supplier and recorded its inventory at purchased cost of US$50 dollar per item. XYZ marketed product A for a selling price of US$54 dollar.
The stocks remained unsold after 2 months, and due to the decreasing raw material prices, the product A buying price for XYZ has decreased to US$48, and the customer is asking for a buying price of US$52 dollar. Is there any net realisable value issue require XYZ to write down its inventory to US$48, prevailing purchase price? The answer is no. According to the accounting standard for inventory - the inventories need to be stated at the lower of cost and net realisable value. The cost of product A was US$50, while the selling price (i.e. net realisable value) was US$52. Hence, no write down is required.
A write-down is required when the market price / selling price drop below US$50.
This is the concept of net realisable value which generally deals with the fluctuation of selling price.
Allowance for stocks obsolescence deals with the long standing stocks, where the specific products remain relatively unsold after a pro-longed period (based on the industry standard). For instance, Company XYZ purchased 50 items of product B, which was expected to be sold within 3 months, whilst the inventory turnover for the industry is about 4 months. However, after 9 months, 10 items of product B remain unsold. This could be due to the commcerial obsolescence where product B is no longer in demand by the market. Management of Company XYZ should evaluate this and consider to provide allowance for stocks obsolescence.
Generally, allowance for stocks obsolescence deal with long standing stocks.
Let's examine the following example.
Company XYZ purchased a product A from its supplier and recorded its inventory at purchased cost of US$50 dollar per item. XYZ marketed product A for a selling price of US$54 dollar.
The stocks remained unsold after 2 months, and due to the decreasing raw material prices, the product A buying price for XYZ has decreased to US$48, and the customer is asking for a buying price of US$52 dollar. Is there any net realisable value issue require XYZ to write down its inventory to US$48, prevailing purchase price? The answer is no. According to the accounting standard for inventory - the inventories need to be stated at the lower of cost and net realisable value. The cost of product A was US$50, while the selling price (i.e. net realisable value) was US$52. Hence, no write down is required.
A write-down is required when the market price / selling price drop below US$50.
This is the concept of net realisable value which generally deals with the fluctuation of selling price.
Allowance for stocks obsolescence deals with the long standing stocks, where the specific products remain relatively unsold after a pro-longed period (based on the industry standard). For instance, Company XYZ purchased 50 items of product B, which was expected to be sold within 3 months, whilst the inventory turnover for the industry is about 4 months. However, after 9 months, 10 items of product B remain unsold. This could be due to the commcerial obsolescence where product B is no longer in demand by the market. Management of Company XYZ should evaluate this and consider to provide allowance for stocks obsolescence.
Generally, allowance for stocks obsolescence deal with long standing stocks.
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