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May 30, 2008

Why is a product that sells for $50 reported in inventory at its cost of $40?

Generally, items in inventory are valued at their cost–not their selling prices–because of the cost principle.

Another reason for not valuing items in inventory at their selling prices is that inventory items cannot be sold without a sales effort. Until that effort is made and an item is actually sold, the company cannot report the $10 increase from $40 to $50. This is referred to as the revenue recognition principle. In other words, only after an item is actually sold can the company report the revenue of $50 minus the cost of $40 for a gross profit of $10.

There are some exceptions to cost. One exception is industries where no sales effort is required and the extensive effort of production has been completed. In these industries the inventory can be reported at its net realizable value, which is the sales value minus the costs to dispose of the items. The gold mining industry and certain other commodities are examples of this exception to cost.

Another exception can occur in any industry when a product will have to be sold for less than its cost. In that situation the item might be reported in inventory close to its net realizable value, provided it is less than the item’s cost. (U.S. income tax rules require conformity between tax and financial reporting. As a result, there are complexities involved.)

Learn more about Lower of Cost or Market.

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About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.



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Comments

24 Responses to “Why is a product that sells for $50 reported in inventory at its cost of $40?”

  1. Safi on June 2nd, 2008 11:16 pm

    What is the Inventory Entry and GL entry for Sales and Purchase (both traded goods and RM)

  2. emmysil on June 3rd, 2008 4:49 am

    can’t really thank you enough but the materials posted to this sight are really helpful.
    thank you

  3. Aralamo on June 3rd, 2008 5:54 am

    Pls, Continue the good work you people are doing, knowledge is an invaluable asset that one can possess.

    Many thanks and God Bless.

  4. sreenivas on June 3rd, 2008 6:14 am

    Good. Please provide info like this on regular basis. It is helping lot for learning and preparing for interviews

  5. Timothy on June 3rd, 2008 1:28 pm

    Great information

  6. Amos on June 3rd, 2008 2:10 pm

    The main reason for this valuation is the cost principle and one important thing to add here is that we should say lower of cost or net realisable value instead of lower of cost or market price.

  7. AKMAL on June 3rd, 2008 10:36 pm

    thanks very much, its really inovrmative

  8. RASHID on June 4th, 2008 1:16 am

    REALLY GOOD INFORMATION, BUT PLEASE TELL US REGARDING INVENTORY EVALUATION IN RESPECT OF TAX SAVING FOR THE COMPANY.

  9. igwe on June 4th, 2008 4:12 am

    Your news letter is education centre, accept it but you must continue.

  10. Pelenato Ioane on June 4th, 2008 4:26 pm

    Appreciate all your independent views, but its good to see that this is part of continiuing education program in our accountantcy profession.

  11. Lekan Ajifowobaje on June 4th, 2008 11:23 pm

    This is a great educative information. Please keep it up.

  12. kesavan on June 5th, 2008 1:33 am

    why don’t you tell that the inventroy is valued at cost or netrealisable value whichever is lower. it is not always valued at cost. In oder to satisfy the prudence concept it should be valued at lower of cost or net realisable.
    i hope you will be considering this information
    thank you

  13. omodunbi modupeola on June 5th, 2008 2:06 am

    this is really informative and educative.i really appreciate this

  14. Yohana Daniel on June 6th, 2008 3:44 am

    i was once an Accounting layman but now becoz of A/cc Coach i can do things i didnt with regard to A/cc, big up

  15. Noor on June 8th, 2008 12:01 am

    Dear,

    I need to know how to print all accounting note.

    With best regards

  16. Humair on June 8th, 2008 11:59 pm

    Dear, kindly refer IAS 2, where NRV is emphasised for valuing inventories not just cost and this is not industry dependent.

  17. igwe on June 11th, 2008 6:54 am

    as we should not count what we do not have, so it is not to add to cost what we
    have not realised. We add to cost we have
    realised it, it will therefore be prudent enough.

  18. MERHAWIT on June 13th, 2008 9:04 am

    thankyou for the questions. keep on it

  19. Tariq on June 16th, 2008 7:08 am

    I wanna know about coast Accounting

    Best Regards

  20. MIR AYYAS ALI on June 23rd, 2008 9:12 am

    i required to know about the difference between trade&cash discount &how it is accounted for

  21. Wizozo2000 on July 24th, 2008 6:20 am

    informative and educative.

  22. julius on October 8th, 2008 3:34 am

    Hi,thanks for the great work i really appreciate and i have learn t a lot on this site,but please i request that you should also discuss for us topics in cost accounting.

    Thanks.

  23. mohsen on October 28th, 2008 11:56 am

    your explanation is very good . thank you

  24. ISHARA on January 16th, 2009 5:21 am

    These are realy helpful to study

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