Inventory valuation and net realisable value (VCE Accounting Unit 3)
“Valuing inventory at the lower of cost and net realisable value and recording inventory write-downs, inventory losses and inventory gains, including the effect on the accounting reports”
Inventory is reported at the lower of its cost and its net realisable value, the estimated selling price less any costs of selling. When net realisable value falls below cost, the inventory is written down and the loss is an expense. Inventory loss and gain arise when a physical count differs from the inventory card, and both are recorded against the card.
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What this dot point is asking
VCAA wants you to apply the lower of cost and net realisable value rule, record an inventory write-down, and distinguish and record an inventory loss and an inventory gain, explaining the effect on the Income Statement and Balance Sheet.
The lower of cost and net realisable value rule
Net realisable value is the estimated selling price of inventory in the ordinary course of business, less the estimated costs necessary to make the sale. Inventory is reported at whichever is lower, its cost or its net realisable value.
The rule applies the qualitative characteristic of faithful representation: an asset must not be carried at more than the amount expected to be recovered from selling it. If net realisable value is above cost, no adjustment is made, because inventory is never written up above cost.
Inventory write-down
When net realisable value is below cost, the inventory is written down to net realisable value. The reduction is recorded as Inventory Write-Down, an expense (other expense) in the Income Statement, with a credit to Inventory reducing the carrying amount on the card.
Compare cost with net realisable value line by line. Write down only the lines where net realisable value is lower; do not net a write-down on one line against a higher net realisable value on another, and never write inventory up above cost.
Inventory loss and gain
An inventory loss occurs when a physical stocktake counts fewer units than the inventory card shows (theft, damage, spoilage). It is recorded as Inventory Loss (expense), credit Inventory. An inventory gain occurs when the count shows more units than the card; it is recorded as a credit to Inventory Gain (a revenue or negative expense), debit Inventory. Both are recorded at cost using the relevant cost layer.
Write-down scenario
A line of inventory has 100 units on the card at a cost of 30 dollars each (3,000 dollars). The selling price has fallen and net realisable value is now 26 dollars per unit. Net realisable value 2,600 is below cost 3,000, so write down by 3,000 minus 2,600 = 400 dollars. Entry: Debit Inventory Write-Down 400, Credit Inventory 400. The card now shows 100 units valued at 2,600.
Inventory loss scenario
A second line shows 50 units on the card at 40 dollars (2,000 dollars), but a stocktake finds only 47 units. Three units are missing at 40 each = 120 dollars. Entry: Debit Inventory Loss 120, Credit Inventory 120. The card is reduced to 47 units (1,880 dollars).
Inventory gain scenario
A third line shows 20 units at 15 dollars (300 dollars), but the count finds 22 units. Two extra units at 15 = 30 dollars. Entry: Debit Inventory 30, Credit Inventory Gain 30. The card rises to 22 units (330 dollars).
Report effect
The Income Statement shows an Inventory Write-Down expense of 400 and an Inventory Loss expense of 120, reducing profit by 520, partly offset by Inventory Gain revenue of 30, a net reduction of 490. The Balance Sheet reports the corrected, lower inventory carrying amounts.
Estimating net realisable value
Net realisable value is the expected selling price less the costs still needed to make the sale. In exam scenarios the selling price is usually a reduced or discounted price, and the costs to sell can include items such as advertising the clearance, delivery to the customer, or the cost of a free gift bundled with each unit. The order of work is always the same:
- Start from the realistic selling price (use the discounted price if the stock has been marked down).
- Subtract every cost still required to achieve that sale, on a per unit basis.
- Compare the resulting net realisable value per unit with the cost per unit on the inventory card.
- Value the line at the lower figure, writing it down only if net realisable value is below cost.
A free gift given away with each item is a selling cost: its cost reduces net realisable value because the business must give it up to make the sale. Students who forget the gift overstate net realisable value and miss the write-down.
Net realisable value and faithful representation
The lower of cost and net realisable value rule is a direct application of the Conceptual Framework. Faithful representation requires an asset to be reported at no more than the future economic benefit it can deliver. If inventory can only be sold for less than it cost, carrying it at cost would overstate the asset and overstate profit, because the loss has effectively already occurred. Recognising the write-down in the period the value falls (rather than waiting until the goods are sold) also applies the accrual basis and the period assumption.
Why this matters
These adjustments keep the Inventory asset faithfully represented and stop profit being overstated by carrying stock above what it can fetch. The write-down is a balance day adjustment that examiners pair with the lower of cost and net realisable value rule, and inventory loss or gain is a favourite stocktake question.
Students sometimes adjust inventory to net realisable value in both directions. Inventory is only ever written down, never up. If net realisable value exceeds cost, leave the inventory at cost; recognising the higher value would overstate the asset and breach faithful representation.
Exam-style questions
Questions in the style of VCAA exam questions on this dot point, each with a worked answer. They are written by ExamExplained unless tagged "Past paper"; the year shows the paper a question is modelled on.
2021 VCAA-style2 marksSeven large pots remain on hand at 28 February 2021 at a cost of $160 each. The owner discounted them to $100 each (plus GST), gives away a watering can (cost $10 plus GST) with every pot sold, and free delivery of the seven pots costs Garden Leaf $105 (plus GST). Calculate the total value of the large pots at 28 February 2021 after applying the lower of cost and net realisable value rule.Show worked answer →
Net realisable value is the estimated selling price less the costs of selling. Work it per pot, then compare with cost.
NRV per pot: selling price $100, less the watering can given away $10, less delivery 105 / 7 = 75**.
Compare: cost $160 versus NRV $75. The rule requires the lower, so each pot is valued at $75.
Total value = 7 x 525**. (The inventory is written down from cost 7 x 1 120 to $525.) One mark for the correct NRV per unit, one for the $525 total.
2025 VCAA-style3 marksOn 30 September 2025, 30 football jumpers (FIFO cost $82 each) were on hand. They normally sell for $110 each (plus GST) but the owner decided to sell them at a reduced price of $75 each (plus GST), with a free coffee cup (cost $5 plus GST, sells for $10) given away with each jumper sold. This was noted in Memo 63. Prepare the General Journal entry required to record Memo 63. A narration is required.Show worked answer →
A write-down is required when net realisable value falls below cost.
NRV per jumper: reduced selling price $75 less the coffee cup given away $5 = $70. Cost is $82, which is higher than NRV 12 per jumper.
Total write-down = 30 x 360**.
General Journal entry:
Debit Inventory Write-Down (expense) $360; Credit Inventory $360. Narration: "Write-down of 30 football jumpers to net realisable value (Memo 63)."
One mark for the correct NRV (recognising the free cup as a selling cost), one for the $360 amount, and one for the correct debit and credit accounts with a narration. GST is not affected because no sale has yet occurred.