Measurement of inventory

Under IFRS, Inventory is reported on BS at 

  • Lower of cost or Net realizable value
  • Net realizable value (NRV) (13)
    • Expected sales price – estimated selling cost – completion cost
    • Inventory is written down (14) to NRV
      • NRV <   cost (previously report on BS as inventory)
      • Loss is recognized in IS 
    • Inventory is Written up (15) when NRV increase but still less than cost
      • NRV < cost and NRV increased
      • Gain is recognized in IS 
      • Gain = increase in NRV

Under U.S. GAAP, inventory is reported at 

  • Lower of cost or market (16)
  • Market (16) = min (replacement cost, NRV) or max(replacement cost, NRV – normal profit margin)
    • Usually equal to replacement cost 
    • Smaller than NRV
    • Larger than NRV – normal profit margin
  • Cost > market 
    • Inventory is written down to market on BS 
    • Decrease in value is recognized in IS by 
      • Increase COGS for small changes in value 
      • Record the loss from the inventory write-down separately
    • If there is a subsequent recovery: 
      • No write-up allowed under US GAAP
  • LIFO is less likely to recognize inventory writedown than firm using FIFO or weighted average cost
    • LIFO is using most recent cost of inventory for COGS
    • Writedown is recognized when original cost of inventory is higher than NVR
    • NVR reflects market price of inventory in current accounting period
    • For ending inventory, its original cost usually lower than NRV
  • Writedown affect inventory turnover in current and future period
    • Inventory turnover = sales/ average inventory
    • Writedown → reduce average inventory of current period → increase inventory turnover in future period
  • Under IFRS and US GAAP, reporting inventory above historical cost is permitted
    • Inventory is reported at NRV
    • Gains and losses from changing market prices are recognized in IS
  • Writedown are usually the result of poor inventory management
    • Buy too much inventory when market price is slowing down → original cost > market, NVR


Replacement cost 

  • Expense a business must undertake to replace an essential asset of the company at the same or equal value at the present time.
  • The cash outlay that firm has to pay in order to replace an old asset at the current market price.