Lower of cost and net realisable value

IAS 2.9 requires inventory to be measured at the lower of cost and net realisable value (NRV). Assets shouldn't be carried at more than the cash they are expected to bring in.

NRV = estimated selling price in the ordinary course of business − estimated costs to complete − estimated costs necessary to make the sale (commissions, delivery to the customer). NRV is entity-specific: it's what this business expects to get, which can differ from fair value.

Why might NRV fall below cost? Damage, obsolescence, falling selling prices, a product being discontinued, or costs to complete rising. When it does, the inventory is written down to NRV and the write-down is expensed in the period (IAS 2.34) — usually within cost of sales.

Item by item. Write-downs are normally made item by item (IAS 2.29), or for groups of similar items that are related to the same product line. You can't offset a loss on one product against a gain on an unrelated one: comparing total cost with total NRV would hide the problem.

Raw materials. Materials held for production aren't written down if the finished products they go into are expected to sell at or above cost (IAS 2.32). If finished goods will sell below cost, the materials are written down — replacement cost may be the best evidence of their NRV.

Evidence. NRV is estimated at the reporting date using the most reliable evidence available when the estimates are made — including sales shortly after the year end that confirm conditions existing at the year end (an adjusting event under IAS 10).

Reversal. NRV is reassessed every period. If the circumstances that caused a write-down no longer exist, or NRV increases, the write-down is reversed (IAS 2.33) — but only up to the original write-down, so the new carrying amount is the lower of cost and the revised NRV. The reversal reduces the inventory expense of the period in which it occurs.

US GAAP (ASC 330) uses lower of cost and NRV for inventory measured under FIFO or average cost, but lower of cost or market for LIFO and the retail method — and it prohibits reversing a write-down: the written-down amount becomes the new cost.