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Lower of Cost or Net Realizable Value

Lesson
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Inventory is normally recorded at cost. Sometimes, however, it loses value. It may become obsolete, or see an increase in competitive offerings, or may enjoy less demand in the marketplace.

When the value of inventory goes down, the value on its owners books also has to go down.

The lower of cost or net realizable value is one such method. Do note, however it cannot be used for LIFO or retail inventory method systems.

The net realizable value is the expected selling price minus the costs to complete the sale (such as sales commissions).

There are two methods for recording a writedown via journal entries:

  • COGS method - "Hides" the loss as part of cost of goods sold, obscuring what happened.
  • Loss method - "Shows" the loss as its own line item, clarifying what happened.
Question
Bill corp., the ever-maligned wig importer, has an item that it is thinking about selling.

Here's what you know:

  • The item was originally purchased for $150.

  • The item can now be sold for $100.

  • The managers believe it will take an additional $8 to sell.

What are the journal entries, required to show the effects of the lower of cost or net realizable value using the loss method?
Answer
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👉 Answer:

  • Loss on decline in inventory     $58.00    
         Inventory     $58.00    

👨‍🎓 This is how we solve it:

  1. First, let's remember the formula for net realizable value
    NET REALIZABLE VALUE = NEW SELLING PRICE - COSTS TO COMPLETE SALE
  2. Calculate the net relizable value (NRV)
    $92.00 = $100.00 - $8.00
  3. Choose the lower value of the original cost and the net relizable value (NRV)
    $92.00 = LOWER OF ($150.00, $92.00)
  4. Compute the reduction in value that must be written off:
    INVENTORY VALUE REDUCTION = ORIGINAL COST - LOWER VALUE
  5. Let's fill in the numbers
    $58.00 = $150.00 - $92.00
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