What is the difference between lower of cost and NRV under IFRS versus LCM under US GAAP?

Question

AcadiFi · Accepted Answer

This is one of the most tested IFRS vs. GAAP differences in CFA Level I FRA. Let me break it down clearly.

```mermaid
flowchart TD
    A["Inventory Valuation"] --> B["IFRS: IAS 2"]
    A --> C["US GAAP: ASC 330"]
    B --> D["Lower of Cost and NRV"]
    C --> E["Lower of Cost or Market"]
    D --> F["NRV = Selling Price − Costs to Complete − Selling Costs"]
    E --> G["Market = Replacement Cost
(bounded by ceiling and floor)"]
    G --> H["Ceiling = NRV"]
    G --> I["Floor = NRV − Normal Profit Margin"]
```

**IFRS Approach (IAS 2) — Simpler**

Compare cost to NRV. NRV = estimated selling price minus estimated costs to complete and sell. If NRV < cost, write down to NRV.

**Example:** Belmont Electronics carries 500 units of a tablet at $320 each (cost). Market conditions have dropped. Estimated selling price is $290, and selling costs are $15 per unit.
- NRV = $290 - $15 = **$275**
- Cost = $320
- Write-down = $320 - $275 = **$45 per unit** (total $22,500)

**US GAAP Approach (ASC 330) — More Complex**

"Market" means replacement cost, but it is bounded:
- **Ceiling** = NRV (can't exceed this)
- **Floor** = NRV minus normal profit margin

Market = replacement cost, but capped at the ceiling and floored at the floor.

Using the same Belmont Electronics example, suppose replacement cost is $260 and normal profit margin is $30 per unit:
- NRV (Ceiling) = $275
- Floor = $275 - $30 = $245
- Replacement cost = $260 (between $245 and $275, so Market = $260)
- Write-down = $320 - $260 = **$60 per unit**

**Key difference on reversals:**

| Feature | IFRS | US GAAP |
|---------|------|--------|
| Measurement | Lower of cost and NRV | Lower of cost or market |
| Write-down reversal | **Allowed** (up to original cost) | **Not allowed** |
| LIFO permitted? | No | Yes |

The reversal rule is critical: if market conditions improve next year, IFRS lets Belmont reverse the write-down (but never above the original $320 cost). US GAAP does not — the write-down establishes a new, permanent cost basis.

**Exam tip:** When a CFA Level I question asks about inventory write-downs, first identify which standard applies (IFRS or GAAP), then apply the correct comparison. The GAAP ceiling/floor test is a frequent exam trap.

Practice more inventory questions in our CFA Level I question bank.

What is the difference between lower of cost and NRV under IFRS versus LCM under US GAAP?

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Related Questions

Practice Questions

Feature	IFRS	US GAAP
Measurement	Lower of cost and NRV	Lower of cost or market
Write-down reversal	Allowed (up to original cost)	Not allowed
LIFO permitted?	No	Yes