Learn how lower of cost and net realizable value limits inventory carrying amounts, with an NRV calculation, write-down example, and GAAP-versus-IFRS differences.
The lower of cost and net realizable value rule requires applicable inventory to be reported at the lower of its recorded cost or the amount expected to be recovered from sale after estimated completion and selling costs. When net realizable value (NRV) falls below cost, the entity recognizes an inventory write-down and expense.
Under IFRS, this lower-of-cost-and-NRV principle applies broadly to inventory within IAS 2. Under U.S. GAAP, it generally applies to inventory measured using methods other than LIFO or the retail inventory method; those excluded categories retain the lower-of-cost-or-market model.
A simplified formula is:
NRV = estimated selling price - estimated completion costs - estimated costs necessary to make the sale
Under U.S. GAAP, the definition refers to reasonably predictable costs of completion, disposal, and transportation. Under IAS 2, NRV is the estimated selling price in the ordinary course of business less estimated completion costs and costs necessary to make the sale.
The estimate should reflect the inventory’s condition, purpose, contracts, and evidence available at the measurement date. A headline retail price can be misleading if the company expects discounts, returns, finishing work, commissions, freight, or disposal costs.
A furniture maker has 100 unfinished desks with a total recorded cost of $48,000. Management estimates:
$600 per desk;$90 per desk; and$45 per desk.NRV per desk = $600 - $90 - $45 = $465
Total NRV = 100 x $465 = $46,500
Because recorded cost of $48,000 exceeds NRV of $46,500, the inventory is written down by $1,500.
A simplified direct entry is:
| Account | Debit | Credit |
|---|---|---|
| Inventory write-down expense or cost of goods sold | $1,500 | |
| Inventory | $1,500 |
An entity may use an allowance presentation when permitted by its accounting policy and framework. The economics are the same: inventory and current-period income decrease.
A slow-moving item is not automatically worthless, and a recent purchase cost is not automatically recoverable. Management needs evidence linking expected quantity and price to the actual market and inventory condition.
| Issue | U.S. GAAP | IFRS under IAS 2 |
|---|---|---|
| Inventory subject to direct lower-of-cost-and-NRV | Generally inventory not measured using LIFO or the retail method | Inventory within IAS 2, subject to its scope exceptions |
| LIFO inventory | Uses lower of cost or market | LIFO is not permitted |
| Measurement unit | Applied using the grouping that best reflects periodic income under applicable guidance | Usually item by item; similar or related items may sometimes be grouped |
| Later NRV recovery | Write-down generally establishes a new cost basis; reversal is generally prohibited | Reversal is required when NRV recovers, limited to the original write-down |
This difference can make later gross margins diverge. An IFRS company may recognize a reversal when market conditions improve, while a comparable U.S. GAAP company generally waits for the written-down inventory to be sold.
| Measure | Core idea | Typical inventory use |
|---|---|---|
| Net realizable value | Entity-specific expected selling proceeds less completion and selling costs | Recoverability ceiling under IAS 2 and for non-LIFO inventory under U.S. GAAP |
| Market under traditional LCM | Current replacement cost constrained by a ceiling and floor | U.S. GAAP LIFO and retail-method inventory |
| Fair value | Market-participant exit-price measurement under the applicable standard | Not the default measurement for ordinary inventory, though scope exceptions exist |
| Replacement cost | Cost to replace inventory in current conditions | Input to traditional U.S. GAAP LCM, not NRV itself |
Using the wrong measure can materially change a write-down. If selling price remains stable but replacement cost falls, NRV may be unchanged even though traditional LCM could produce a different result for covered inventory.
Inventory measurement can materially affect earnings and tax reporting. This page is educational and is not accounting, audit, tax, or investment advice.