Write down item by item through cost of goods sold; an ending error flips next year; one ratio

Cost is a ceiling

Inventory is carried at cost — but only while the goods are worth at least that. ASPE s.3031 measures inventory at the lower of cost and net realisable value (NRV), where NRV is the estimated selling price in the ordinary course of business, less the estimated costs to complete and to sell. If a line of packs has gone out of fashion and will fetch less than it cost, the loss is recognised now, in the period the value fell, not when the packs eventually sell.

The test is applied item by item (or by line of similar items), not to the inventory as a whole — because grouping lets an item that rose in value hide an item that fell. Bramble Lane Outfitters Ltd. at 31 December:

Item by item the inventory is 7,850 and the write-down is 8,300 − 7,850 = 450. Tested in total, cost 8,300 is below NRV 8,350 and the write-down is nil — line B's 500 gain (which ASPE never lets you record) has hidden A's and C's 450 loss. That is why the level matters.

Dec 31  Cost of Goods Sold                   450
            Inventory                                450

The write-down is an expense of the period, charged to cost of goods sold by default (a separate loss line is acceptable but not the norm). The US rule — lower of cost or market, with replacement cost — is not ASPE; the ceiling here is what the goods will sell for, net. If NRV later recovers, the write-down is reversed, up to the amount originally written down and never above cost — the one place in this course where ASPE does reverse (PP&E impairments, Module 11, are never reversed).

An ending-inventory error lives for two years

Suppose Bramble Lane's year-1 count overstated ending inventory by 5,000. Year 1's cost of goods sold (opening + net purchases − ending) is understated by 5,000, so year 1 net income is overstated 5,000. But year 1's ending inventory is year 2's opening inventory: year 2's cost of goods sold is overstated by 5,000 and year 2 net income understated 5,000. Year 2's ending inventory is counted fresh and is correct.

The error self-corrects: retained earnings at the end of year 2 are right, because the 5,000 over in year 1 and the 5,000 under in year 2 cancel. Each year's income statement is wrong; the two-year total is not. An error found in year 3 needs no entry — only a note that the comparatives were misstated.

Cut-off

The commonest source of such an error is cut-off: goods that arrived on 31 December, FOB shipping point, whose invoice was not recorded until January. They were counted (they are on the floor) but not recorded as a purchase, so inventory is right and purchases are 3,200 short — cost of goods sold understated, income overstated, payables understated. The fix, before the books close:

Dec 31  Inventory                          3,200
            Accounts Payable                       3,200

One ratio

Inventory turnover is cost of goods sold divided by average inventory — how many times the shelves were sold through in the year:

$$\text{Inventory turnover}=\frac{\text{COGS}}{\text{Average inventory}}=\frac{210,300}{(38,200+41,150)÷2}=\frac{210,300}{39,675}=5.30$$

Days in inventory is 365 ÷ 5.30 ≈ 69. A falling turnover on a steady margin means stock is building. The gross-margin method — estimating inventory from sales and a historical margin after a fire — is an estimate for interim or insurance purposes, never a substitute for the count.