Inventory at Net Realizable Value

  • International and U.S. accounting standards require companies to carry inventory on the balance sheet at the lower of cost or market (LCM).

  • With LCM an unrealized loss caused by a change that materially disconnects the in the fair market value of current inventory from the most recently reported book value of inventory must be immediately recognized.

  • This will lower the book value of assets on the balance sheet and reduce profit.

  • Example: The feature music file sharing device sold by an electronics chain has just become obsolete due to the advances offered by a new device that is not sold by this chain.  Regardless of inventory accounting method, the electronics chain must write down its inventory and take a write down charge on its income statement to more accurately reflect true financial position and performance.

  • Internationally (IFRS-IAS), net realizable value represents the cost to finalize and sell inventory.

  • In the US (GAAP), market value is generally estimated as the present replacement cost of the inventory.