Final answer:
The 'lower of cost and net realisable value' rule ensures the reliability and accuracy of financial reporting by preventing the overstatement of inventory values, aligning with the conservatism principle and the qualitative characteristic of a faithful representation.
Step-by-step explanation:
The 'lower of cost and net realisable value' rule is applied when valuing inventory to comply with the conservatism principle in accounting. This principle dictates that businesses should report the least optimistic estimate of profits, which aims to prevent overstatement of financial positions and performance. This valuation rule is relevant because it safeguards against inventory being reported at a value higher than the amount that can be realized through its sale. It aligns with the qualitative characteristic of reliability, ensuring the reported financial information is a faithful representation of the entity's financial status.
Since inventory can potentially be sold for less than its cost due to damage, obsolescence, or market price declines, valuing inventory at the lower of cost and net realisable value ensures that the value of assets and profits are not overstated on the financial statements. This approach thereby maintains reliability and accuracy in financial reporting, supporting informed decision-making by users of the financial statements.