Prepared by

Coby Harmon
University of California, Santa Barbara
Westmont College
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 Inventories: CHAPTER 9
Additional Valuation Issues
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe and apply the lower-of- 4. Determine ending inventory
cost-or-net realizable value rule. by applying the retail
2. Identify other inventory valuation inventory method.
issues. 5. Explain how to report and
3. Determine ending inventory by analyze inventory.
applying the gross profit
method.

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 PREVIEW OF CHAPTER 9

Intermediate Accounting
IFRS 3rd Edition
Kieso ● Weygandt ● Warfield
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 LEARNING OBJECTIVE 1
Lower-of-Cost-or-Net Describe and apply the lower-
of-cost-or-net realizable value
Realizable Value rule.

(LCNRV)
A company abandons the historical cost principle when the
future utility (revenue-producing ability) of the asset drops
below its original cost.

Net Realizable Value

Estimated selling price in the normal course of business less
 estimated costs to complete and
 estimated costs to make a sale.

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 Net Realizable Value

Illustration: Assume that Mander AG has unfinished inventory

with a cost of €950, a sales value of €1,000, estimated cost of
completion of €50, and estimated selling costs of €200. Mander’s
net realizable value is computed as follows.

ILLUSTRATION 9.1
Computation of Net Realizable Value

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 Net Realizable Value ILLUSTRATION 9.1
Computation of Net
Realizable Value

 Mander reports inventory on its balance sheet at €750.

 In its income statement, Mander reports a Loss on
Inventory Write-Down of €200 (€950 − €750).

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 Net Realizable Value

ILLUSTRATION 9.2
LCNRV Disclosures

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 Illustration of LCNRV

Jinn-Feng Foods computes its inventory

ILLUSTRATION 9.3
at LCNRV (amounts in thousands). Determining Final
Inventory Value

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 Methods of Applying LCNRV

Assume that Jinn-Feng Foods separates its food products

into two major groups, frozen and canned.

ILLUSTRATION 9.4
Alternative Applications of LCNRV

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 Methods of Applying LCNRV

 In most situations, companies price inventory on an item-

by-item basis.
 Tax rules in some countries require that companies use an
individual-item basis.
 Individual-item approach gives the lowest valuation for
statement of financial position purposes.
 Method should be applied consistently from one period to
another.

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 Recording NRV Instead of Cost

Illustration: Data for Ricardo SpA

Cost of goods sold (before adj. to NRV) €108,000
Ending inventory (cost) 82,000
Ending inventory (at NRV) 70,000

Loss Loss Due to Decline to NRV 12,000

Method Inventory (€82,000 - €70,000)

12,000
COGS Cost of Goods Sold 12,000
Method Inventory

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 Recording NRV Instead of Cost

Partial Statement of Financial Position

Loss COGS
Method Method
Current assets:
Inventory € 70,000 € 70,000
Prepaids 20,000 20,000
Accounts receivable 350,000 350,000
Cash 100,000 100,000
Total current assets 540,000 540,000

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 Recording Net Realizable Value
Loss COGS
Income Statement Method Method
Sales € 200,000 € 200,000
Cost of goods sold 108,000 120,000
Gross profit 92,000 80,000
Operating expenses:
Selling 45,000 45,000
General and administrative 20,000 20,000
Total operating expenses 65,000 65,000
Other income and expense:
Loss due to decline of inventory to NRV 12,000 -
Interest income 5,000 5,000
Total other (7,000) 5,000
Income from operations 20,000 20,000
Income tax expense 6,000 6,000
Net income € 14,000 € 14,000
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 Use of an Allowance

Instead of crediting the Inventory account for NRV adjustments,

companies generally use an allowance account, often referred to
as Allowance to Reduce Inventory to NRV.
Using an allowance account under the loss method, Ricardo SpA
makes the following entry to record the inventory write-down to
NRV.

Loss Due to Decline of Inventory to NRV 12,000

Allowance to Reduce Inventory to NRV 12,000
ILLUSTRATION 9-7

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 Use of an Allowance

Partial Statement of Financial Position

No
Allowance Allowance
Current assets:
Inventory € 70,000 € 82,000
Allowance to reduce inventory (12,000)
Inventory at NRV 70,000
Prepaids 20,000 20,000
Accounts receivable 350,000 350,000
Cash 100,000 100,000
Total current assets 540,000 540,000

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 LCNRV

Recovery of Inventory Loss

 Amount of write-down is reversed.
 Reversal limited to amount of original write-down.

Continuing the Ricardo example, assume the net realizable

value increases to €74,000 (an increase of €4,000). Ricardo
makes the following entry, using the loss method.

Allowance to Reduce Inventory to NRV 4,000

Recovery of Inventory Loss 4,000

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 Recovery of Inventory Loss

Allowance account is adjusted in subsequent periods, such

that inventory is reported at the LCNRV.
Illustration shows net realizable value evaluation for Vuko Company
and the effect of net realizable value adjustments on income.

ILLUSTRATION 9.8
Effect on Net Income of Adjusting
Inventory to Net Realizable Value

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 Evaluation of LCM Rule

LCNRV rule suffers some conceptual deficiencies:

1. A company recognizes decreases in the value of the asset
and the charge to expense in the period in which the loss in
utility occurs—not in the period of sale.
2. Application of the rule results in inconsistency because a
company may value the inventory at cost in one year and at
net realizable value in the next year.
3. LCNRV values the inventory in the statement of financial
position conservatively, but its effect on the income statement
may or may not be conservative. Net income for the year in
which a company takes the loss is definitely lower. Net
income of the subsequent period may be higher than normal if
the expected reductions in sales price do not materialize.
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 LCNRV
P9.1: Remmers SE manufactures desks. The 2019 catalog was in
effect through November 2019, and the 2020 catalog is effective as of
December 1, 2019. At December 31, 2019, the following finished
desks appear in the company’s inventory.

Finished Desks A B C D
2019 Catalog selling price € 450 € 480 € 900 € 1,050
FIFO cost per inventory list 12/31/19 470 450 830 960
Estimated cost to complete and sell 50 110 260 200
2020 catalog selling price 500 540 900 1,200

Instructions: At what amount should the four desks appear in the

company’s December 31, 2019, inventory, assuming that the company
has adopted a lower-of-FIFO-cost-or-net realizable value approach for
valuation of inventories on an individual-item basis?
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 LCNRV
Instructions: At what amount should the four desks appear in the
company’s December 31, 2019, inventory, assuming that the company
has adopted a lower-of-FIFO-cost-or-net realizable value approach for
valuation of inventories on an individual-item basis?

Finished Desks A B C D
2019 Catalog selling price € 450 € 480 € 900 € 1,050
FIFO cost per inventory list 12/31/19 470 450 830 960
Estimated cost to complete and sell 50 110 260 200
2020 catalog selling price 500 540 900 1,200

Net Realizable Value € 450 € 430 € 640 € 1,000

Lower-of-Cost-or-NRV 450 430 640 960

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 LEARNING OBJECTIVE 2
Valuation Bases Identify other inventory
valuation issues.

Net Realizable Value

Departure from LCNRV rule may be justified in situations when
 cost is difficult to determine,
 items are readily marketable at quoted market prices, and
 units of product are interchangeable.

Two common situations in which NRV is the general rule:

 Agricultural assets
 Commodities held by broker-traders.

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 Presentation and Analysis

Presentation of Inventories
Accounting standards require disclosure of:
5) Amount of any write-down of inventories recognized as
an expense in the period and the amount of any reversal
of write-downs recognized as a reduction of expense in
the period.

6) Circumstances or events that led to the reversal of a

write-down of inventories.

7) Carrying amount of inventories pledged as security for

liabilities, if any.

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 Presentation and Analysis

Analysis of Inventories
Common ratios used in the management and evaluation of
inventory levels are inventory turnover and average days
to sell the inventory.

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 Analysis of Inventories

Inventory Turnover
Measures the number of times on average a company sells
the inventory during the period.

Illustration: In its 2015 annual report Tate & Lyle plc (GBR)
reported a beginning inventory of £372 million, an ending inventory
of £263 million, and cost of goods sold of £1,319 million for the
year.

ILLUSTRATION 9.25

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 Analysis of Inventories

Average Days to Sell Inventory

Measure represents the average number of days’ sales for
which a company has inventory on hand.
ILLUSTRATION 9.25

Average Days to Sell

365 days / 3.59 times = every 101.7 days

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 GLOBAL ACCOUNTING INSIGHTS

LEARNING OBJECTIVE 6
Compare the accounting for inventories under IFRS and U.S. GAAP.

Inventories
In most cases, IFRS and U.S. GAAP related to inventory are the same. The
major differences are that IFRS prohibits the use of the LIFO cost flow
assumption and records market in the LCNRV differently.

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 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Following are the key similarities and differences between U.S. GAAP and
IFRS related to inventories.
Similarities
• U.S. GAAP and IFRS account for inventory acquisitions at historical cost
and evaluate inventory for lower-of-cost-or-net realizable value (market)
subsequent to acquisition.
• Who owns the goods—goods in transit, consigned goods, special sales
agreements—as well as the costs to include in inventory are essentially
accounted for the same under U.S. GAAP and IFRS.

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 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Differences
• U.S. GAAP provides more detailed guidelines in inventory accounting. The
requirements for accounting for and reporting inventories are more
principles-based under IFRS.
• A major difference between U.S. GAAP and IFRS relates to the LIFO cost
flow assumption. U.S. GAAP permits the use of LIFO for inventory
valuation. IFRS prohibits its use. FIFO and average-cost are the only two
acceptable cost flow assumptions permitted under IFRS. Both sets of
standards permit specific identification where appropriate.

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 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Differences
• In the lower-of-cost-or-market test for inventory valuation, U.S. GAAP
defines market as replacement cost subject to the constraints of net
realizable value (the ceiling) and net realizable value less a normal markup
(the floor). IFRS defines market as net realizable value and does not use a
ceiling or a floor to determine market.
• Under U.S. GAAP, if inventory is written down under the lower-of-cost-or-
market valuation, the new basis is now considered its cost. As a result, the
inventory may not be written up back to its original cost in a subsequent
period. Under IFRS, the write-down may be reversed in a subsequent
period up to the amount of the previous write-down. Both the write-down
and any subsequent reversal should be reported on the income statement.
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 GLOBAL ACCOUNTING INSIGHTS

Relevant Facts
Differences
• IFRS requires both biological assets and agricultural produce at the point of
harvest to be reported at net realizable value. U.S. GAAP does not require
companies to account for all biological assets in the same way.
Furthermore, these assets generally are not reported at net realizable value.
Disclosure requirements also differ between the two sets of standards.

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 GLOBAL ACCOUNTING INSIGHTS

On the Horizon
One convergence issue that will be difficult to resolve relates to the use of the
LIFO cost flow assumption. As indicated, IFRS specifically prohibits its use.
Conversely, the LIFO cost flow assumption is widely used in the United States
because of its favorable tax advantages. In addition, many argue that LIFO
from a financial reporting point of view provides a better matching of current
costs against revenue and therefore enables companies to compute a more
realistic income.

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 Copyright

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