ACCA Advanced Audit and Assurance (AAA) Practice Exam

What is net realizable value?

1. The total historical cost of inventory

2. The estimated selling price less all costs needed to complete the sale

3. The expected income from investments

4. The fixed cost of production

The correct answer is: The estimated selling price less all costs needed to complete the sale

Net realizable value is a key concept in accounting that represents the amount for which an asset can be sold, minus any costs associated with the sale. Specifically, for inventory, it is determined by taking the estimated selling price and deducting the costs necessary to complete the sale, such as manufacturing costs, shipping, and selling expenses. This measure helps ensure that inventory is reported at a value that reflects its true economic potential. Understanding net realizable value is vital for proper asset valuation, especially in scenarios of potential decline in market value. It allows businesses to avoid overstating their assets and ensures a more accurate representation of their financial position. In contrast, total historical cost of inventory refers to the original cost paid for inventory, which does not necessarily reflect current market conditions or realizable potential. Expected income from investments and fixed cost of production do not relate to the valuation of inventory, as they pertain to different aspects of financial reporting.