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CS Executive · Corporate Accounting and Financial Management · Introduction to Accounting

Kapoor Ltd. had stock costing Rs 5,00,000 at year end. Its net realisable value was Rs 4,60,000. The accountant valued the stock at Rs 4,60,000 but would not have recorded any gain had the realisable value been Rs 5,60,000. Which convention does this behaviour illustrate, and what is the effect on profit of the Rs 4,60,000 valuation?

It illustrates conservatism, also called prudence: anticipate possible losses but not unrealised gains. Stock is written down from Rs 5,00,000 to Rs 4,60,000, so closing stock and therefore profit are reduced by Rs 40,000.

  1. AConservatism; profit reduced by Rs 40,000Correct
  2. BConservatism; profit increased by Rs 60,000
  3. CConsistency; profit reduced by Rs 40,000
  4. DMateriality; profit unchanged

Explanation

Stock is valued at lower of cost and net realisable value. Anticipating a possible loss of Rs 40,000 (5,00,000 - 4,60,000) while ignoring an unrealised gain follows the convention of conservatism (prudence). Closing stock is lower by Rs 40,000, so profit falls by that amount. Consistency concerns using the same method year to year, not this asymmetry.

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