A warehouse holds 200 devices from an older product generation. Each carries a recorded cost of SAR 180. The price list still shows SAR 220, yet recent actual sales achieve no more than SAR 175, with a further SAR 10 per device needed for preparation and sale. Which figure belongs in the inventory assessment? The printed price list is not enough.
Under IAS 2, net realisable value starts with the expected selling price in ordinary business, less estimated completion and selling costs. The accounting comparison is between that amount and cost, not between cost and management's hope of recovering an old price. This educational example assumes the SAR 10 captures all relevant necessary costs included in the estimate.
The test that uncovered SAR 3,000
The expected net amount per device is SAR 175 less SAR 10, or SAR 165. Compared with a cost of SAR 180, that indicates a SAR 15 reduction per unit. Across 200 devices, the adjustment is SAR 3,000, leaving a carrying amount of SAR 33,000 instead of SAR 36,000.
This does not mean the business paid out SAR 3,000 today or has already sold every device. It reflects that expected recovery from the inventory no longer covers its recorded cost. Confusing a measurement effect with a cash movement can postpone recognition until liquidation, when commercial action may also be late.
The useful next question is what supports SAR 175. Are there recent independent sales at that price? Was it a limited promotion or a recurring achievable level? Does the entire quantity deserve the same estimate? A device with damaged packaging may differ from an intact device even if both share the same main product code.
A short evidence file beats a blanket percentage
Prepare a review sheet for each appropriately homogeneous group of units, recording quantity, condition, cost, price evidence, selling costs and reviewer. The aim is not paperwork volume. Another person should be able to understand the conclusion without asking the preparer to explain every cell.
- Date the price evidence. An offer made before a replacement model launched may no longer describe the market.
- Distinguish a unit price from a bundle price, and a straightforward sale from one that includes extra services.
- Consider returns, preparation and seller-funded shipping in light of the actual sales terms.
- Explain why an unexecutable offer was excluded rather than simply selecting the highest available price.
“Slow-moving” alone does not determine a write-down. A slow-selling item may retain a sound price, while a fast-selling item may move only because its clearance price is below cost. Aging and movement reports help direct attention; they do not replace an estimate of recoverable amounts.
When the clearance plan does not add up
Management might propose selling all 200 devices within a month even though recent monthly sales have not exceeded 20. The weakness is then in the commercial assumption, not the spreadsheet formula. The plan needs an explanation: a confirmed buyer, a credible new channel or executable orders. Otherwise, prices or preparation requirements may change before the units are sold.
Use a simple sensitivity analysis to expose uncertainty. If the selling price falls to SAR 165 while completion and selling costs remain SAR 10, net recovery becomes SAR 155 and the reduction becomes SAR 5,000 for the same quantity. The worse scenario is not automatically the required estimate. It shows how strongly the result depends on the selling-price assumption.
Separate two questions in the commercial meeting: what amount should be reported now, and what action could reduce the eventual loss? Faster clearance, repackaging or negotiating a supplier return may be worth pursuing. Do not postpone the current assessment for a plan that has not happened, and do not treat an accounting entry as a substitute for managing physical stock.
A useful estimate can be reviewed when new evidence emerges. Keep an explanation of differences between forecast recovery and actual sales. Repeated gaps may reveal overlooked preparation costs or an excessive reliance on list prices. That feedback turns the inventory review into a learning process rather than an annual form completed solely to close the books.
Sources & further reading
Visit the original source to explore the concept and its wider context.
General educational content. Appropriate treatment depends on your business and accounting policies; consult your accounting professional when applying it to business records.
