9-1

CHAPTER

INVENTORIES:
ADDITIONAL VALUATION ISSUES

Intermediate Accounting
IFRS Edition
Kieso, Weygandt, and Warfield

9-2

Learning
Learning Objectives
Objectives

9-3

1.

Describe and apply the lower-of-cost-or-net realizable value rule.

2.

Explain when companies value inventories at net realizable value.

3.

Explain when companies use the relative sales value method to

value inventories.

4.

Discuss accounting issues related to purchase commitments.

5.

Determine ending inventory by applying the gross profit method.

6.

Determine ending inventory by applying the retail inventory

method.

7.

Explain how to report and analyze inventory.

Inventories:
Inventories: Additional
Additional Valuation
Valuation Issues
Issues
Lower-of-Costor-Net
Realizable
Value (LCNRV)

9-4

Net realizable
value
Illustration of
LCNRV
Application of
LCNRV
Recording net
realizable
value
Use of an
allowance
Recovery of
inventory loss
Evaluation of
rule

Valuation
Bases
Special
valuation
situations
Relative sales
value
Purchase
commitments

Gross Profit
Method
Gross profit
percentage
Evaluation of
method

Retail
Inventory
Method
Concepts
Conventional
method
Special items
Evaluation of
method

Presentation
and Analysis
Presentation
Analysis

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

9-5

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Net Realizable Value
Estimated selling price in the normal course of
business less estimated costs to complete and
estimated costs to make a sale.
Illustration 9-1

9-6

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Net Realizable Value

9-7

Illustration 9-2
LCNRV Disclosures

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Illustration of LCNRV: Regner Foods computes its
inventory at LCNRV.
Illustration 9-3

9-8

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Methods of Applying LCNRV
Illustration 9-4

9-9

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
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.

9-10

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Recording Net Realizable Value Instead of Cost
Cost of goods sold (before adj. to NRV)
Ending inventory (cost)
Ending inventory (at NRV)
Loss
Loss
Method
Method
COGS
COGS
Method
Method
9-11

Loss due to decline to NRV

$ 108,000
82,000
70,000
12,000

Inventory
12,000
Cost of goods sold

12,000

Inventory
12,000
LO 1 Describe
and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Statement of Financial Position Presentation
Partial Statement

9-12

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Income Statement Presentation

9-13

LO 1

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Use of an Allowance
Instead of crediting the Inventory account for net realizable
value adjustments, companies generally use an
allowance account.
Loss
Loss
Method
Method

Loss due to decline to NRV

12,000

Allowance to reduce
inventory to NRV
12,000

9-14

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Statement of Financial Position Presentation
Partial Statement

9-15

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
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
Recovery of inventory loss

9-16

4,000
4,000

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Recovery of Inventory Loss
Allowance account is adjusted in subsequent periods,
such that inventory is reported at the LCNRV.
Illustration 9-8

Inventory should not be reported at a value above original cost.

9-17

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
Evaluation of LCM Rule
Some Deficiencies:

9-18

Decreases in the value of the asset and the charge to expense are
recognized in the period in which the loss in utility occursnot in the
period of sale.

Increases in the value of the asset (in excess of original cost)

recognized only at the point of sale.

Inconsistency because a company may value inventory at cost in one

year and at net realizable value in the next year.

LCNRV values inventory conservatively. 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.
LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
P9-1: Remmers Company manufactures desks. Most of the
companys desks are standard models and are sold on the basis of
catalog prices. At December 31, 2010, the following finished desks
appear in the companys inventory.

Instructions: At what amount should the desks appear in the

companys December 31, 2010, 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?
9-19

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Lower-of-Cost-or-Net
Lower-of-Cost-or-Net Realizable
Realizable Value
Value
P9-1: Remmers Company manufactures desks. Most of the
companys desks are standard models and are sold on the basis of
catalog prices. At December 31, 2010, the following finished desks
appear in the companys inventory.

9-20

LO 1 Describe and apply the lower-of-cost-or-net realizable value rule.

Valuation
Valuation Bases
Bases
Special Valuation Situations
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.

9-21

LO 2 Explain when companies value inventories at net realizable value.

Copyright
Copyright
Copyright 2011 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.

9-22