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CMA Foundation · Fundamentals of Financial and Cost Accounting · Four Frameworks of Accounting and Forms of Organization

Nair Electronics values its closing stock at cost ₹1,20,000, while its net realisable value is ₹1,05,000. It records stock at ₹1,05,000, thereby recognising the expected fall in value but not any possible gain. Which concept is applied, and what is the effect on profit?

Conservatism is applied, and profit reduces by ₹15,000. Stock is valued at the lower of cost ₹1,20,000 and net realisable value ₹1,05,000, so closing stock falls by ₹15,000. This increases cost of goods sold and decreases profit, recognising the anticipated loss.

  1. AConservatism; profit reduces by ₹15,000Correct
  2. BGoing concern; profit reduces by ₹15,000
  3. CConservatism; profit increases by ₹15,000
  4. DRealisation; profit is unchanged

Explanation

Valuing stock at the lower of cost and net realisable value is an application of conservatism (prudence). Closing stock is lowered by ₹1,20,000 - ₹1,05,000 = ₹15,000, so cost of goods sold rises and profit falls by ₹15,000. Increasing profit would require valuing stock higher, which is the opposite effect.

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