Valuing Closing Stock at the Lower of Cost and NRV

When you prepare the financial statements at the end of an accounting period, one of the most commonly miscalculated items is closing stock. Many SPM candidates assume closing stock is always valued at cost, but stock must be valued at the lower of cost and net realisable value (NRV). A small mistake here flows through to cost of sales, gross profit, net profit and the total current assets in the Statement of Financial Position.

This guide explains what cost and net realisable value mean, why the prudence concept applies, how to calculate the value item by item, and how the result affects the accounts. All examples follow the KSSM Prinsip Perakaunan syllabus (code 3756).

What do cost and net realisable value mean?

Cost of stock refers to all costs incurred to bring the stock to its present location and condition. This includes the purchase price, import duties, carriage inwards and other related costs. Purchases returns and trade discounts are deducted because they reduce the actual amount paid.

Net realisable value is the estimated selling price in the ordinary course of business, less the estimated costs to complete the stock and the estimated costs necessary to make the sale, such as packaging or sales commission. In short, NRV is the net amount a business expects to receive if it sells the stock.

Why do we take the lower value?

This rule comes from the prudence concept. Prudence requires a business not to overstate its assets and not to recognise profits that have not yet been earned, while recognising likely losses as soon as they are foreseen.

When NRV is lower than cost, it signals that the stock may not sell at its original price, perhaps because it is damaged, obsolete or the market price has fallen. By valuing at the lower NRV, the business recognises this possible loss early and avoids reporting an asset at an unrealistic amount.

The correct calculation steps

The first step is to determine the cost of each type of stock. The second step is to work out the NRV for each type of stock. The third step is to compare cost with NRV and take whichever is lower. This comparison should be made item by item, not by totalling all the stock first.

For example, Item A has a cost of RM800 and an NRV of RM950, so RM800 is taken. Item B has a cost of RM1,200 and an NRV of RM1,000, so RM1,000 is taken because it is lower. The closing stock value is RM800 + RM1,000 = RM1,800, not RM2,000.

Effect on the Trading Account

Closing stock is deducted in the calculation of cost of sales. The basic formula for cost of sales is opening stock plus net purchases less closing stock. Therefore, if closing stock is overstated, cost of sales becomes too low and gross profit is overstated.

Conversely, when stock is valued at the lower NRV, cost of sales rises slightly and gross profit becomes more prudent. This is how the prudence concept absorbs the fall in stock value into the profit of the current period.

Effect on the Statement of Financial Position

Closing stock is reported as a current asset in the Statement of Financial Position at the lower of cost and NRV. This ensures the asset is not shown at more than the amount reasonably expected to be recovered from it.

Note that the same figure must be used in both places, that is, in the Trading Account and in the Statement of Financial Position. Using two different figures in the two statements is a common error to avoid.

Common candidate mistakes

The first mistake is always taking cost without checking the NRV. The second is comparing total cost against total NRV rather than doing it item by item. The third is wrongly adding selling costs such as commission into the cost of stock, when they should instead be deducted in the NRV calculation.

Another mistake is forgetting to deduct carriage outwards or selling costs from the selling price when computing NRV, or wrongly using the full selling price as the stock value. Repeated practice with a variety of scenarios will help you spot these traps.

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FAQ

Is NRV the same as selling price? No. NRV is the selling price less the estimated costs to complete and sell the stock, so it is usually lower than the full selling price.

Do I need to compare each item separately? Yes, the correct practice is to compare cost with NRV item by item, then add up the lower value of each item to get the overall closing stock figure.

What if NRV is higher than cost? If NRV is higher, we still take cost because we choose the lower value. We do not increase the stock value above its cost.