Lower of Cost or Market vs Net Realizable Value

Lesson

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Sometimes the value of inventory drops below its original cost. Consider a cellphone. It could be worth quite a bit upon release, but a couple of years later? It will be worth a tiny fraction of its original cost, because newer, better things are available. Similarly, other items expire. Consider a pallet of fresh food. The longer it's in inventory, the less desirable (and valuable) it becomes.

So how do we adjust the value of inventory to adjust for these changes? We have two popular systems to choose from: Lower of Cost or Net Realizable Value.

The rule of thumb is that LCM is the default option, unless it's a US company that uses the LIFO or the retail inventory method.

Question

You're the CFO for Ginny LLC and need to decide on an inventory method for your firm.

Here's what you know:

The firm uses FIFO for inventory management.

Which should be used, LCM or NRV?

Answer

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👉 Answer:

The firm should use Lower of Cost and Net Relizable Value.

👨‍🎓 This is how we solve it:

Firms that use FIFO should be using the lower of Cost and Net Realizable Value (LVNRV).

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