Business – 10.1 Financial statements – Inventory valuation | e-Consult
10.1 Financial statements – Inventory valuation (1 questions)
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Valuing inventory at NRV can lead to a lower inventory figure compared with historical cost when NRV < cost. This reduction influences several ratios:
- Current Ratio (Current Assets / Current Liabilities): A lower inventory reduces current assets, potentially decreasing the current ratio, indicating reduced short‑term liquidity.
- Gross Profit Margin (Gross Profit / Revenue): Since cost of goods sold is based on the inventory value, a lower opening inventory can increase COGS if the write‑down is recognised as an expense, reducing gross profit and thus lowering the gross profit margin.
Other ratios such as Return on Assets may also be affected because a lower asset base can increase ROA if net profit remains unchanged, giving a more favourable efficiency measure. Overall, the NRV method provides a more conservative view of asset values, which can make liquidity appear weaker but efficiency ratios appear stronger.