How does lower of cost and net realizable value work for inventory under GAAP?

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AcadiFi · Accepted Answer

For inventory measured with methods such as FIFO or average cost, GAAP uses lower of cost and net realizable value. Net realizable value is expected selling price minus reasonably predictable costs of completion, disposal, and transportation. If NRV falls below cost, write inventory down and recognize a loss in the current period. Under US GAAP, that write-down is generally not reversed later for these inventories.

Example: Ironcrest Retail carries winter jackets at a cost of $140,000. By year-end, demand weakens and the jackets can be sold for $132,000 after a planned markdown. Selling and delivery costs will be $7,000, so NRV is $125,000. Because cost exceeds NRV by $15,000, Ironcrest records loss on inventory write-down of $15,000 and credits inventory by $15,000. The new carrying amount becomes $125,000.

If the next quarter the jackets become popular again and NRV rises to $138,000, GAAP does not let Ironcrest reverse the $15,000 loss. That is a common exam point. Also, do not overcomplicate the rule with old ceiling and floor language unless the question clearly points to LIFO or retail inventory. On FAR, the safest move is usually cost versus NRV and a one-way write-down. Practice more in our CPA FAR question bank.

How does lower of cost and net realizable value work for inventory under GAAP?

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