LCNRV by Item, Category or Total Inventory

LCNRV by item means comparing each inventory item’s cost with its net realizable value (NRV), keeping the lower amount, and adding those amounts. LCNRV stands for lower of cost or net realizable value. Because no item’s excess can offset another item’s loss, the item basis never gives a smaller write-down than a category or total test.

A category or total-inventory test reverses the order of operations. Add cost and NRV within the chosen group first, then make one comparison for that group.

The order matters when some products have lost value and others can still earn a margin. Four products in the example below have a combined cost of $20,000. The same facts yield three different carrying amounts (the inventory value reported on the balance sheet), depending on where the comparison takes place.

Watch Professor Farhat explain the inventory valuation rule

In this lecture, Professor Farhat explains the lower of cost or net realizable value rule. Watch it first, then use the worked example below to apply the rule to individual items, categories, and total inventory.

Watch the full inventory valuation lecture on YouTube (15:46).

Start with one inventory list

Suppose Meridian Workshop has two product lines, task lighting and wall clocks. It uses first-in, first-out (FIFO) under U.S. generally accepted accounting principles (GAAP). Its year-end worksheet gives the following batch totals. Net realizable value (NRV) already includes the deductions for finishing, selling, and transporting the goods. Review how to calculate inventory NRV if the problem gives you selling prices instead.

Before doing any arithmetic, mark the two batches whose NRV falls below cost. The Beam lamps and Dial clocks are the only sources of potential loss. The other two batches tell you how much of those losses could be offset if the comparison is made across a wider group.

How LCNRV by item works

For each product, circle the lower number on its row. Arc lamps stay at $6,000, Beam lamps fall to $3,400, Dial clocks fall to $4,200, and Ring clocks stay at $4,500. The sum is $18,100. Against $20,000 of cost, that leaves a $1,900 write-down. A write-down reduces the inventory balance and records the decline as a loss in the current period.

You can check the result by adding only the shortfalls. The Beam lamps lost $600 and the Dial clocks lost $1,300. The $1,400 excess on Arc lamps and the $400 excess on Ring clocks contribute zero to this calculation. Each item is tested on its own, so extra value on one item never offsets a loss on another.

How major categories and total inventory change the result

Compare within each major category

Lighting costs $10,000 and has NRV of $10,800. Keep lighting at $10,000. Clocks cost $10,000 and have NRV of $9,100. Carry clocks at $9,100. Adding the two selected amounts gives $19,100, a $900 write-down. The Arc lamps absorb the entire $600 decline on Beam lamps within lighting. The Ring clocks absorb only $400 of the $1,300 decline within clocks.

Compare the entire inventory

Across all four products, total NRV is $19,900 against total cost of $20,000. This comparison produces $19,900 of inventory and a $100 write-down. Pooling lets the $800 excess left in lighting absorb most of the $900 shortfall left in clocks. This third result shows the arithmetic of total pooling, but it would be hard to defend for Meridian. ASC 330 points to a total-inventory test mainly when a business has one end-product category. Lamps and clocks are unrelated product lines, so an item or category basis fits these facts better.

What Journal Entry Records Each Result?

The entry looks the same under every basis. Only the amount changes. Here is Meridian’s entry on an item-by-item basis:

Debit: Cost of Goods Sold (or Loss Due to Decline of Inventory to NRV) $1,900
Credit: Inventory (or Allowance to Reduce Inventory to NRV) $1,900

On a major-category basis, the amount is $900. On a total-inventory basis, it is $100. A substantial and unusual inventory loss should be disclosed in the financial statements (ASC 330-10-50-2).

Which level should a business use?

Accounting Standards Codification (ASC) 330 directs a business to consider the nature and composition of the inventory and choose the approach that most clearly reflects periodic income. Item-by-item testing is common. Components used together in a single end product may be evaluated together, but only when they are held in balanced quantities. If the stock of one component is excessive compared with the others, or if items go into unrelated products or turn over at very different rates, test those items one by one (ASC 330-10-35-10 and 35-11). If a business cannot classify categories effectively, it applies the rule item by item. Distinct product lines may support separate major categories. A shared warehouse, by itself, tells you little about whether the goods recover their costs together.

Apply the selected basis consistently. A reporting period with unusually poor results gives management no reason on its own to switch to a broader basis. On a problem that specifies a basis, use that instruction and label the answer. See FASB’s ASU 2015-11, which shows the current wording of ASC 330-10-35-8 through 35-11.

A frequent worksheet error is to add amounts already reduced to NRV and call the result a group test. That simply repeats the item calculation. For each group, return to the original cost and NRV columns. The resulting shortfall is the amount carried into the inventory write-down journal entry.

Does LCNRV Apply to LIFO and the Retail Inventory Method?

No. Under ASC 330, LCNRV applies to inventory measured using first-in, first-out (FIFO), average cost, or any other method except last-in, first-out (LIFO) and the retail inventory method.

Inventory measured using LIFO or the retail inventory method still follows the older lower of cost or market (LCM) rule. The choice between item, category, and total inventory applies under both rules. Under LCM, the comparison uses designated market, determined from replacement cost subject to the net realizable value ceiling and the floor of net realizable value less a normal profit margin. Meridian’s NRV amounts alone are therefore insufficient to determine the LCM write-downs.

If your problem uses LIFO, review the lower of cost or market rule. If it uses retail prices, see the retail inventory method.

How Does IFRS Handle LCNRV by Item?

Under IFRS, IAS 2 Inventories usually writes inventory down to net realizable value item by item.

It allows grouping similar or related items, such as items in the same product line that have similar uses, are produced and marketed in the same area, and cannot practicably be evaluated separately. It does not allow a write-down based on a broad classification, such as all finished goods or all inventory in an operating segment. That means the total-inventory test shown above would generally not be acceptable under IFRS.

The two frameworks also differ after the write-down. IFRS reverses a write-down when net realizable value recovers. The reversal is limited to the original write-down, and the resulting carrying amount is the lower of original cost and revised net realizable value. Under U.S. GAAP, a year-end write-down becomes the new cost and is not reversed later.

Read a summary of IAS 2 at IAS Plus.

Key Takeaways

• Item by item: compare cost and NRV for each item, then add the lower amounts. This never gives a smaller write-down than a grouped test.
• Category or total: add cost and NRV for the group first, then compare once. Extra NRV on one item can offset a shortfall on another item in the same group.
• In the Meridian example, the same $20,000 of inventory produces write-downs of $1,900 (item), $900 (category), and $100 (total).
• ASC 330 lets a business choose the basis that most clearly reflects periodic income, then apply it consistently. Item by item is the most common practice.
• Group components only when they are held in balanced quantities. Test excess stock and items used in unrelated products one by one.
• On an exam, use the basis the problem names and label your answer.

Practice questions and answers

Can a group have a loss when its combined NRV exceeds its cost?

No. Suppose two items in one valid group cost $100 each and have NRVs of $70 and $140. The group’s cost is $200 and its NRV is $210, so the group test yields zero loss. Testing each item separately would record a $30 loss on the first item.

When will all three approaches agree?

All three agree when no comparison group mixes items above cost with items below cost. That happens when every item’s NRV is at or below its cost, so every approach records the full shortfall. It also happens when every item’s NRV is at or above its cost, so no approach records a write-down. The item and category results also match whenever each category holds only items on the same side of cost, even if the total-inventory result differs.

Which answer goes on Meridian’s worksheet if the policy specifies major categories?

Report $19,100 and a $900 write-down. The $100 shortfall obtained by comparing company-wide totals crosses the category boundary specified by the policy.

Interactive LCNRV practice by item, category, and total inventory

Read the passage, then answer five questions about choosing and consistently applying an inventory valuation approach.