DON HONORIO VENTURA STATE UNIVERSITY

COLLEGE OF BUSINESS STUDIES

Bacolor, Pampanga

CHAPTER 11 Part 1- LCNRV and Inventory Estimation

LEARNING OBJECTIVES:

At the end of this chapter, the student should be able:

1. To know the measurement of inventory in the statement of financial position

2. To explain the lower of cost and net realizable value basis of measurement

3. To account for inventory write-down using allowance method and direct method

4. To identify the methods of estimating inventory value

5. To discuss the common reasons for making an estimate of the cost of the goods on hand

MEASUREMENT OF INVENTORY

PAS 2 Paragraph 9 provides that Inventories shall be measured at the Lower of Cost and Net
Realizable Value.

The measurement of inventory at the lower of cost and net realizable value is known as LCNRV.

NET REALIZABLE VALUE

Net Realizable Value or NRV is the estimated selling price in 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:

1. The inventories are damaged

2. The inventories have become wholly or partially obsolete

3. The selling prices have declined

4. The estimated cost of completion or the estimated cost of disposal has increased.

DETERMINATION OF NET REALIZABLE VALUE

Inventories are usually written down to net realizable value on an item by item or individual basis.

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.

INTERMEDIATE ACCOUNTING 1 1
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

METHODS OF ACCOUNTING FOR THE INVENTORY WRITEDOWN

a. Direct Method or Cost of Goods Sold Method

b. Allowance Method or Loss Method

DIRECT METHOD

This method is also known as Cost of Goods Sold Method.

The inventory is recorded at the lower of cost or NRV

ALLOWANCE METHOD

The inventory is recorded at cost and any loss on inventory write down is accounted for separately.

This method is also known as “Loss Method” because a loss account “Loss on Inventory Write down
is debited and Allowance for Inventory Write down is credited.

If the required allowance increases, an additional loss is recognized.

If the required allowance decreases, a gain on reversal of inventory write down is recorded.

However, the gain is limited only to the extent of the allowance balance.

In addition, PAS 2 Paragraph 36 requires disclosure of the amount of any inventory write down and
the amount of any reversal of inventory write down.

Illustration: INVENTORY DATA ON DECEMBER 31, 2021

Category 1 Cost NRV LCNRV

A 110,000 100,000 100,000

B 690,000 750,000 690,000

C 600,000 640,000 600,000

Sub-Total 1,400,000 1,490,000

INTERMEDIATE ACCOUNTING 1 2
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Category 2 Cost NRV LCNRV

D 2.000,000 1,900,000 1,900,000

E 1,500,000 1,560,000 1,500,000

Sub-Total 3,500,000 3,460,000

Category 3 Cost NRV LCNRV

F 1,500,000 1,460,000 1,460,000

G 1,600,000 1,690,000 1,600,000

Sub-Total 3,100,000 3,150,000

Grand Total 8,000,000 8,100,000 7,850,000

LCNRV item by item or 7,850,000

individual

Cost NRV LCNRV

Category 1 1,400,000 1,490,000 1,400,000

Category 2 3,500,000 3,460,000 3,460,000

Category 3 3,100,000 3,150,000 3,100,000

LCNRV by Category 7,960,000

Cost NRV LCNRV

LCNRV by Category 8,000,000 8,100,000 8,000,000

The inventory is measured at the lower of cost and net realizable value is applied on an item by
item or individual basis

INTERMEDIATE ACCOUNTING 1 3
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Cost- December 31, 2021 8,000,000

Net Realizable Value (LCNRV) 7,850,000

Loss on Inventory Write Down 150,000

DIRECT METHOD

The inventory is recorded at the lower of cost or NRV

Dec 31 Inventory, End P 7,850,000

Income Summary P 7,850,000

The Loss on Inventory Write Down of P 150,000 is not accounted for separately.

ALLOWANCE METHOD

The inventory is recorded at Cost

Dec 31 Inventory, End P 8,000,000

Income Summary P 8,000,000

The Loss on Inventory Write Down is accounted for separately.

Dec 31 Loss on Inventory Write Down P 150,000

Allowance for Inventory P 150,000

Write down

The loss on inventory write down is included in the computation of cost of goods sold.

The allowance for inventory write-down is presented as a deduction from the inventory

Inventory- December 31, 2021 at cost 8,000,000

Allowance for Inventory Write Down (150,000)

Net Realizable Value 7,850,000

INTERMEDIATE ACCOUNTING 1 4
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Assume on December 31, 2022, the total cost of the inventory is P 8,500,000 and the net realizable
value id P 8,400,000.

DIRECT METHOD

The inventory is recorded at the lower of cost or NRV

Dec 31 Inventory, End P 8,400,000

Income Summary P 8,400,000

ALLOWANCE METHOD

Cost- December 31, 2022 8,500,000

Net Realizable Value 8,400,000

Required Allowance- December 31, 2022 100,000

Less: Allowance balance- December 31, 2021 150,000

Decrease in Allowance 50,000

The decrease in allowance is a reversal of the previous inventory write down and recorded as gain
on reversal of write down.

Allowance for Inventory Write P 50,000

down

Gain on reversal of inventory P 50,000

write down

The gain on reversal of inventory write down is presented as a deduction from cost of goods sold.

INTERMEDIATE ACCOUNTING 1 5
 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

USE OF ESTIMATE IN INVENTORY VALUATION

In many cases, it is necessary to know the approximate value of inventory when it is not possible to
take a physical count.

Even if the physical count is possible, the same may prove costly, difficult or inconvenient at the
moment.

There are two accepted procedures for approximating the value of inventory, namely the gross
profit method and the retail inventory method.

COMMON REASONS FOR MAKING AN ESTIMATE OF THE COST OF GOODS ON HAND ARE:

1. The inventory is destroyed by fire and other catastrophe, or theft of the merchandise has
occurred and the amount of inventory is required for insurance purposes.

2. A physical count of the goods on hand is made and it is necessary to prove the correctness
or reasonableness of such count by making an estimate.

3. Interim Financial statements are prepared and a physical count of the goods is not
necessary because it may take time to do the same.

Moreover, only an estimate is required to fairly present the financial position and financial
performance of the entity for interim reporting purposes.

REFERENCES:

Millan, Zeus Vernon. (2020). Intermediate Accounting 1A. Baguio City: Bandolin Enterprise

Valix Conrado T & Valix Christian Aris M. (2020). Intermediate Accounting. Manila: GIC
Enterprises & Co. Inc.

CPAR, RESA, ICARE Review Materials in Intermediate Accounting or Financial Accounting

INTERMEDIATE ACCOUNTING 1 6