Prudence concept:

The prudence concept is one of the basic accounting principles, which states that while preparing financial statements or recording transactions, the accountant should exercise caution and be conservative in their approach. Under this concept, the accountant should not overestimate the revenues or underestimate the expenses of the entity. This principle ensures that the financial statements of the entity reflect a true and fair view of its financial position and performance.

Valuation of closing stock:

Closing stock refers to the inventory of goods that are unsold at the end of the accounting period. The valuation of closing stock is important because it affects the calculation of cost of goods sold and gross profit of the entity.

According to the prudence concept, the closing stock should be valued at cost or net realizable value (NRV), whichever is less. NRV is the estimated selling price of the inventory minus the estimated costs of completion and disposal.

Reason for using net realizable value:

The use of NRV provides a conservative approach to the valuation of closing stock. This is because it takes into account any potential losses that may arise from the sale of the inventory. For example, if the market price of the inventory has decreased, the NRV will reflect this decrease and the closing stock will be valued at a lower amount.

Using NRV also ensures that the financial statements reflect the economic reality of the entity. This is because the value of the closing stock is based on its estimated selling price in the current market conditions, rather than its historical cost.

Conclusion:

In conclusion, the prudence concept requires the accountant to be conservative in their approach to accounting. The valuation of closing stock should be based on either cost or NRV, whichever is less. Using NRV ensures that the financial statements reflect the economic reality of the entity and provides a conservative approach to the valuation of closing stock.

Market price