Question

Some of M and C Electronics’s merchandise is gathering dust. It is now December 31, 2018, and the current replacement cost of the ending merchandise inventory is \(24,000 below the business’s cost of the goods, which was \)97,000. Before any adjustments at the end of the period, the company’s Cost of Goods Sold account has a balance of $380,000.

Requirements

4. Which accounting principle or concept is most relevant to this situation?

Short answer

The principle of conservatism has been used in this situation.

Step-by-step solution

Step-by-Step SolutionStep 1: Accounting principles in inventory standard

In inventory accounting, there are four principles or concepts that must be followed. These are –

a) Consistency principle

b) Disclosure principle

c) Materiality concept

d) Conservatism

These principles govern inventory accounting and standards.

Accounting principle in the given case

In the given case, the principle of conservatism has been used. As per this principle, there should be reporting of figures at the reduced value and not on overstated value.

The inventory’s realization value has been decreased by a significant amount and becomes lower than the historical cost. In this situation, for every sale, there would be a loss because the cost would be higher than the market value. So, as per the conservatism principle, this loss must be recognized to COGS and the ending inventory would be reported at a lower of cost and net realizable value.