Show Under IFRS, inventories may be measured and carried on the balance sheet at a lower cost and net realizable value. US GAAP, on the other hand, specifies the lower cost or market to value inventories. Market value, for this purpose, is defined as the current replacement cost subject to upper and lower limits. The net realizable value is defined as the estimated selling price in the ordinary course of business less the estimated costs necessary to make the sale and estimated costs to get the inventory in condition for sale. The assessment of net realizable value under IFRS is typically done either item by item or by groups of similar or related items. If the value of inventory declines below the carrying amount on the balance sheet, the inventory carrying amount must be written down to its net realizable value. In addition, the loss should be recognized as an expense on the income statement. This expense can be included as part of the cost of sales or reported separately. A new assessment of net realizable value should be made in each subsequent period. Reversal, which is limited to the amount of the original write-down, is required for a subsequent increase in the value of inventory that was previously written down. The reversal of any write-down of inventories is recognized as a reduction in the cost of sales. US GAAP, although broadly consistent with IFRS, prohibits the reversal of write-downs. The market value cannot exceed the net realizable value given the fact that the lower limit is the net realizable value less a normal profit margin.
learning objective LO3 – Explain and calculate lower of cost and net realizable value inventory adjustments. In addition to the adjusting entry to record the shrinkage of merchandise inventory (discussed in Chapter
5), there is an additional adjusting entry to be considered at the end of the accounting period when calculating cost of goods sold and ending
inventory values for the financial statements. Generally accepted accounting principles require that inventory be valued at the lesser amount of its laid-down cost and the amount for which it can likely be sold — its net realizable value (NRV). This concept is known as the lower of cost and net realizable value, or LCNRV. Note that the laid-down cost includes the invoice price of the goods (less any purchase discounts) plus transportation in, insurance while in transit, and any other
expenditure made by the purchaser to get the merchandise to the place of business and ready for sale. As an example, a change in consumer demand may mean that inventories become obsolete and need to be reduced in value below the purchase cost. This often occurs in the electronics industry as new and more popular products are introduced. The lower of cost and net realizable value can be applied to individual inventory items or groups of similar items, as shown in Figure 6.4.1 below.  Figure \(\PageIndex{1}\): LCNRV Calculations Depending on the calculation used, the valuation of ending inventory will be either $2,600 or $2,650. Under the unit basis, the lower of cost and net realizable value is selected for each item: $1,200 for white paper and $1,400 for coloured paper, for a total LCNRV of $2,600. Because the LCNRV is lower than cost, an adjusting entry must be recorded as follows.
The purpose of the adjusting entry is to ensure that inventory is not overstated on the balance sheet and that income is not overstated on the income statement. If white paper and coloured paper are considered a similar group, the calculations in Figure 6.4.1 above show they have a combined cost of $2,650 and a combined net realizable value of $2,700. LCNRV would therefore be $2,650. In this case, the cost is equal to the LCNRV so no adjusting entry would be required if applying LCNRV on a group basis. Why are inventories measured at lower of cost and net realizable value?Obsolescence, over supply, defects, major price declines, and similar problems can contribute to uncertainty about the “realization” (conversion to cash) for inventory items. Therefore, accountants evaluate inventory and employ lower of cost or net realizable value considerations.
What is the reason for writing down inventories below cost to net realizable value?When inventory is measured as the lower of cost or net realizable value, it is embracing the accounting principle of conservatism. Though NRV may be the most dramatically reduced valuation for inventory, the aim is to reduce the carrying value of goods to not overstate the income statement.
Why are inventories stated at lower of cost and net realizable value quizlet?Terms in this set (20) Why are inventories stated at lower-of-cost and net realizable Value? To permit future profits to be recognized. To report a loss when there is a decrease in the future utility below the original cost.
What is lower of cost and net realizable value example?Example of Net Realizable Value
The cost to prepare the widget for sale is $20, so the net realizable value is $60 ($130 market value - $50 cost - $20 completion cost). Since the cost of $50 is lower than the net realizable value of $60, the company continues to record the inventory item at its $50 cost.
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What is the reason for the inventory measurement at lower of cost and net realizable value?
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