Explanation

When inventory declines in value below its carrying amount on the balance sheet, this is known as inventory impairment or inventory write-down. According to accounting standards (IFRS and US GAAP):

1. Lower of Cost or Market/Net Realizable Value Principle: Inventory must be carried at the lower of cost or market value (US GAAP) or lower of cost and net realizable value (IFRS).

2. Recognition of Loss: When inventory value declines below its carrying amount, the carrying amount must be written down to its market value or net realizable value.

3. Income Statement Impact: The reduction in value is recognized as an expense on the income statement. This expense is typically called:

   • Cost of goods sold (if the inventory is sold)
   • Inventory write-down expense
   • Loss on inventory impairment

4. Why Not Other Options:

   • Option B (decrease in the revaluation surplus account): This applies to revalued assets under IFRS, not inventory. Inventory is not typically revalued above cost.
   • Option C (decrease in the inventory valuation allowance account): While some companies use allowance accounts for inventory obsolescence, the expense still flows through the income statement. The direct write-down method is more common for inventory impairment.

Accounting Entry:

Dr. Inventory Write-down Expense (Income Statement)
Cr. Inventory (Balance Sheet)

Dr. Inventory Write-down Expense (Income Statement)
Cr. Inventory (Balance Sheet)

This reduces both the inventory asset on the balance sheet and recognizes the loss in the income statement, which decreases net income.