Valuation of closing stock at actual cost price or market price whichever is lower is an example of which accounting conversation? explain that convention.
Answers
The valuation of closing stock is an example outlining the Convention of Conservatism, which tells us to anticipate all probable losses in business but we must never ascertain any future profits, incomes or gains. As we value closing stock at the price which is lower among market and cost price, overall value of net assets sees a decrease. However, it is such that one must make provisions for all expected losses (Reserves for Doubtful Debts etc.) but one must NEVER make provisions or expectations about any future profits of a business concern as such we value closing stock at the price which is lower among market and cost prices.
To give you an example, closing stock was 12,000 at cost price and 8,000 at market price. Now, will you consider 12,000 to be placed as the value of closing stock in the books? No, you would not - because as per the principle you must ascertain all fair losses of the business, which in this case is a loss of 4,000 so the amount to be placed as closing stock will be 8,000.
If the amount of cost price was 10,000 and market price was 15,000 - you will would place 10,000 as the value in the books because the principle doesn't allow you to ascertain any profits of the business. Hence, 10,000 would be placed as the value of closing stock.