ACG 3101 Lecture Notes - Lecture 17: Financial Statement
24 Oct 2019
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Chapter 9 Notes part 1
Lowe-of-Cost or Net Realizable Value
• Cost is determined based on chapter 8 – standard, LIFO, FIFO
• Inventory should not be reported higher than the amount we expect to receive for that
item; inventory is an asset
o Valuing it at our future economic benefit and do not want to exaggerate that
benefit
• Net Realizable Value (NRV) or lower of cost – calculated by the estimated selling price
in the ordinary course of business, less reasonably predictable costs of completion,
disposal, and transportation; measurement of what we expect to receive – the profit on
this inventory
o We value the inventory at the lower of either cost or this new value – net
realizable value
o Determine the cost, calculate the net realizable value and want to report the
inventory at the lower of the two numbers
▪ If the net realizable value is lower than the cost, then a journal entry is
required to decrease the cost to the net realizable value
▪ If cost is equal to the net realizable value or lower than it, then no journal
entry is required
o All input will be given to you for NRV
o Most companies use an item-by-item analysis (basis)
o Two methods to recording adjustments for journal entries – mainly just tells you
what account will be debited
▪ Loss Method
• Debit to Loss Due to Decline in Inventory
▪ COGS Method
• Debit to Cost of Goods Sold
▪ Both methods are correct with GAAP, same effect on overall net income,
will calculate a different gross profit though
o Some companies use an allowance account called Allowance to Reduce Inventory
to NRV instead of credited Inventory
▪ It is a permanent account, contra-asset account reducing the inventory
account, it has a normal credit balance
Lower-of-Cost or Market (LCM)
• Compare cost to the measure of market value
• What is the appropriate market value
o Companies will say that the market value is a replacement cost feature but it is
capped at NRV and cannot be lower than NRV – normal profit margin
o To determine the market value, we say it is the replacement cost not greater the
NRV but not lower the NRV – normal profit margin
o These rules only apply to determining the market value
o Rule of thumb: choose the middle number, that will be the market value
o Ceiling is there to prevent overstatement of inventory
o Floor is there to prevent understatement of inventory
