Lower of cost and net realizable value
A newer model is announced and the drills will sell for less: the write-down, the month it lands in, and what it does to the margin.
At month end the supplier announces a newer model, and Northwind expects the old drills to sell for less. Net of what it costs to sell them, each is now worth $52: its net realizable value. The shelf holds 17 at a FIFO cost of $55. FIFO and average-cost inventory is carried at the lower of cost and net realizable value, so the drills are written down by $51 to $884, and the loss lands in October, when the evidence appeared.
Write the drills on the shelf down to what they will now sell for, less the cost of selling them.
| Account | Debit | Credit |
|---|---|---|
| 5100Inventory losses | 51.00 | |
| 1300Inventory | 51.00 | |
| Balanced | 51.00 | 51.00 |
OCT-10
Wrong
1300 Inventory 935 (at cost, until they sell)
Right
1300 Inventory 884 (51 written down in October)
Leaving the drills at cost carries an asset at more than it will ever bring in. The loss belongs to the month the evidence appeared, not to the month the drills finally sell.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Background reading explains; it is never the authority for a rule. Anything marked as a convention is ours, not the rule-maker's.
- US GAAP
- ASC 330-10-35-1B (opens in a new tab)FIFO and average-cost inventory is carried at the lower of cost and net realizable valueFree after registration
- Background reading — not an authority
- Wikipedia, “Lower of cost or market” (opens in a new tab)Lower of cost or marketFree to read
The full map is in US GAAP, and where these rules come from.
The words this page teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- Net realizable valueEstimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. FIFO and average-cost inventory is carried at the lower of cost and NRV, and the shortfall is a loss of the period it arises in
- InventoryGoods held for sale, or being made for sale, carried as an asset at cost until sold — when the cost moves to cost of revenue
- Gross marginGross margin is a profitability metric, calculated as (Revenue − COGS) ÷ Revenue.Convention
See also
- Journal entry for an inventory write-downWhen inventory's net realizable value falls below its cost, debit an inventory write-down expense (often within cost of goods sold) and credit Inventory for the difference.
- Gross marginRevenue less cost of revenue, as a percentage of revenue. It's what's left from each dollar of sales to pay for everything else. As a ratio, it's a metric rather than a GAAP line.