LOWER OF COST

AND
NET REALIZABLE
VALUE
MEASUREMENT
OF INVENTORY
PAS 2, paragraph 9, provides
that inventory shall be
measured at the lower of cost
and net realizable value.

(LCNRV)
The measurement of inventory
at the lower of cost and net Lower of Cost and Net
realizable value is now known as Realizable Value
LCNRV
NET REALIZABLE VALUE (NRV)
- is the estimated selling price on the ordinary course of
business less the estimated cost of completion and the
estimated cost of disposal.

The cost of inventories may not be recoverable under the

following circumstances:

a.The inventories are damaged.

b.The inventories have become wholly or partially obsolete.
c.The selling prices have declined.
d.The estimated cost of completion or estimated cost of
disposal has increased.
ACCOUNTING FOR
INVENTORY WRITEDOWN

If the cost is lower than the net realizable value, there is no

accounting problem because the inventory is measured at
cost and the increase in value is not recognized.

If the net realizable value is lower than cost, the inventory is

measured at net realizable value and the decrease in value
is recognized.

Methods of accounting for inventory write down:

a.Direct method
b.Allowance method or loss method
DIRECT METHOD
The inventory is recorded at the
lower of cost or net realizable value.

Also known as “cost of good sold

method” because aby loss on
inventory writedown is not
accounted for separately but “buried”
in the cost of good sold.
ALLOWANCE METHOD
In subsequent years, this
The inventory is recorded at cost allowance account is adjusted
and any loss on inventory upward or downward depending
writedown is accounted for on the difference between the
separately. cost and net realizable value of
the inventory at year-end.
Also known as “loss method”
because a loss account “loss on If the required allowance
inventory writedown” is debited increases, an additional loss is
and valuation account “allowance recognized.
for inventory writedown” is
credited. If the required allowance
decreases, a gain on reversal of
inventory writedown is recorded.
ALLOWANCE METHOD
However, the gain is limited only to the
extent of the allowance balance.

Preferably, the allowance method is

used in order that the effects of
writedown and reversal of writedown
can clearly identified.

PAS2, par. 36 requires disclosure of

the amount of any inventory writedown
and the amount of any reversal of
inventory writedown.
 Inventory Data on December 31, 2019
ILLUSTRATION
LCNRV BY CATEGORY

LCNRV BY TOTAL

The inventory is measured at the LCNRV on an item by item or

individual basis.

Cost- Dec. 31,2019 8,000,000

Net realizable value 7,850,000
Inventory writedown 150,000
DIRECT METHOD

The inventory is recorded at lower of cost or NRV.

Inventory- Dec. 31,2019 7,850,000

Income Summary 7,850,000

*The loss on inventory writedown of P150,000 is not accounted for

separately.
*This will increase the COGS because the NRV is lower than cost.

ALLOWANCE METHOD
The inventory is recorded at cost.

Inventory- Dec. 31,2019 8,000,000

Income Summary 8,000,000
Continuation.

The loss on inventory writedown is accounted for separately.

Loss on inventory writedown 7,850,000

Allowance for inventory writedown 7,850,000

*The loss on inventory writedown is included in the computation of

COGS.
*This will increase the COGS because the NRV is lower than cost.

Inventory- Dec. 31,2019, at cost 8,000,000

Allowance for inventory writedown ( 150,000 )
Net realizable value 7,850,000
 Assume on December 31, 2020, the total cost of inventory
ILLUSTRATION is P8,500,000 and the net realizable value is P8,400,000

DIRECT METHOD
CONTINUING

The inventory on Dec.31,2020

Inventory- Dec. 31,2019 8,400,000

Income Summary 8,400,000

ALLOWANCE METHOD

Cost- Dec. 31,2019 8,000,000

Net realizable value 8,400,000
Required allowance-Dec.31,2020 100,000
less:Allowance balance-De.2019 150,000
Decrease in allowance ( 50,000)
 The decrease in allowance is a reversal of the previous inventory
writedown and recorded as gain on reversal of writedown.
ILLUSTRATION
CONTINUING

Allowance for inv. writedown 8,400,000

Gain on reversal on inv. writedown 8,400,000

*The gain on reversal of inventory writedown is presented as a

deduction from cost of goods sold

*PAS2 paragraph 34, provides that the amount of any reversal of any
writendown of inventory arising from an increase in net realizable
value shall be recognized as reduction in the amount of inventory
recognized as an expense in the period in which the reversal occurs.

*The amount of inventory recognized as an expense of the period is

actually the cost of good sold during the period.
NOW LET'S
PRACTICE!
Compute for the COGS using:

1.Direct Method
2.Allowance method (before & after inventory writedown)
DIRECT METHOD

Inventory-Jan.1 4,500,000
Net purchases 20,000,000
Goods available for sale 24,500,000
Inventory-Dec. 31 ( 5,300,000)
Cost of Goods Sold 19,200,000

Note: under direct method, the inventory, whether

beginning or ending, is presented at the lower amount.
ALLOWANCE METHOD

Inventory-Jan.1 at cost 4,500,000

Net purchases 20,000,000
Goods available for sale 25,000,000
Inventory-Dec. 31 at cost ( 6,000,000)
COGS before inv. writedown 19,000,000
Loss on inv. writedown for current year 200,000
COGS after inv. writedown 19,200,000

Required allowance-Dec. 31 (6000T-5300T) 700,000

Required allowance-Jan.1 (5000T-4500T) 500,000
Increase in allowance-loss on writedown 200,000
PURCHASE COMMITMENTS
Are obligations of the entity to
acquire certain goods sometime in
the future at a fixed price and fixed
quantity.
A purchase contract has already
been made for the future delivery of
goods fixed in price and in quantity.
If significant or unusual, disclosure is
required in the accompanying notes
to financial statements.
Any losses which are expected to
arise from firm and noncancelable
commitments shall be recognized.
If there is a decline in purchase
price after a purchase commitment
has been made, a loss is recorded
in the period of the price decline
must be noncancelable in order
that the loss purchase commitment
can be recognized.
Thus, if at the end of the reporting
period, the purchase price falls
below the agreed price the
difference is accounted for as debit
to loss on purchase commitments
and a credit to an estimated liability.
ILLUSTRATION
The contract purchase price is P500,000 and the replacement
cost at year-end is P450,000. The market decline of P50,000
is recorded as follows:

Loss on purchase commitment 50,000

Est.liability for purchase commitment 50,000

When the actual purchase is made in the subsequent period

and the current replacement cost drops further to P420,000,
the journal entry is:

Purchases 420,000
Loss on purchase commitment 30,000
Est. liab. for purchase commitment 50,000
Accounts Payable 500,000
LCNRV ADAPTATION
the recognition of a loss on purchase
commitment is an adaptation of the
measurement at the lower of cost or
net realizable value.
Accordingly, if the market price rises
by the time the entity makes the
purchase a gain on purchase
commitment previously recorded.
the amount of gain to be recognized
is limited to the loss on purchase
commitment previously recorded.
 Thus, in the preceding illustration, if the replacement cost of the
purchase commitment is P600,000 when the actual purchase is made
the journal entry to record the actual purchase is:

Purchase 500,000
Est. liability for purchase commitment 50,000
Account payable 500,000
Gain on purchase commitment 50,000

*The purchase is recorded at 500,000 because the purchase commitment of

500,000 is lower than replacement cost of 600,000

The gain on purchase commitment is classified as another income.

 If the replacement cost of the purchase commitment is P480,000 when
the actual purchase is made, the journal entry to record the actual
purchase is:

Purchases 480,000
Est. liability for purch. Commitment 50,000
Accounts payable 500,000
Gain on purchase commitment 30,000

*The purchase is recorded at P480,000 only because the replacement cost

is lower than the purchase commitment of P500,000.

*The gain on purchase commitment is the increase in market price from

450t at year-end to 480t on th date of actual purchase.
DISCLOSURES d.The amount of inventories are
recognized as an expense during the
With respect to inventories the
period.
financial statement shall disclose the
following:
e.The amount of any writendown of
inventories recognized as an expensed
a.The accounting policies adopted in
during the period
measuring inventories including the
cost formula used.
f.The amount of reversal of
writendown that is recognized a in
b.The total carrying amount of
come
inventories and the carrying amount in
classifications appropriate to the
g.The circumstances or events that led
entity.
to reversal of a writedown of
inventories
c.The carrying amount of inventories
carried at fair value less cost of
h.The carrying amount of inventories
disposal.
pledged as security for liabilities.
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