Lower of Cost or Net Realizable Value (LCNRV) in 3 Steps

Lower of cost or net realizable value (LCNRV) is the general U.S. GAAP (generally accepted accounting principles) rule in ASC 330 for inventory measured using methods other than LIFO or the retail method, subject to industry-specific measurement exceptions. Net realizable value (NRV) is the expected selling price minus the costs to complete, sell, and ship. Report the lower amount and record any shortfall as a current-period loss.

In plain terms, the rule asks how much of an item’s recorded cost the business can still recover.

A lamp can still sell for more than it cost to make and require a write-down. The deciding figure is what the business expects to keep after making the sale.

Watch Professor Farhat explain the inventory valuation rule

Use Professor Farhat’s lecture to review the rule, then work through the lamp example below.

Watch the full inventory valuation lecture on YouTube (15:47).

Which inventory uses this rule?

Under U.S. generally accepted accounting principles (GAAP), ASC 330-10-35-1B generally applies this rule to inventory measured using any method other than last-in, first-out (LIFO) or the retail inventory method. That includes first-in, first-out (FIFO), average cost, and specific identification. LIFO and retail method inventory still follow the older lower of cost or market (LCM) rule, explained further down this page. Identifying the cost method tells you which test to use.

The test takes place after the business has assigned costs to its ending inventory. A lower selling price, damage, or an obsolete design can signal a decline. Each gives the accountant a reason to update the sales estimate. Whether an adjustment follows depends on the comparison with cost. For the source, see the Financial Accounting Standards Board (FASB) update that created this rule, ASU 2015-11, Simplifying the Measurement of Inventory.

How to apply lower of cost or net realizable value

Step 1. Establish the recorded cost

Start with the amount assigned to the units still on hand. If you need a refresher on how FIFO, LIFO, and average cost assign those amounts, see our periodic vs perpetual inventory costing worked example. Keep the calculation on one basis throughout. If cost is stated per lamp, calculate the expected recovery per lamp. If cost is given for an entire batch, use the expected proceeds and remaining costs for that batch.

Step 2. Estimate net realizable value

Net realizable value (NRV) is the amount the seller expects to retain from an ordinary sale after paying the reasonably predictable costs still needed to complete, sell, and transport the goods. Start with a supportable selling price. A recent order for the same model and condition can be better evidence than a list price that customers rarely pay.

Inventory NRV = expected selling price − remaining completion costs − selling and transportation costs borne by the seller.

Step 3. Choose the lower figure and measure the loss

If NRV falls below recorded cost, ending inventory equals NRV. Subtract NRV from cost to find the write-down. If NRV equals or exceeds cost, carry the inventory at cost. An expected profit becomes relevant when the sale occurs.

In other words, you never write inventory up above cost just because you expect a profit. You wait and record that profit when the sale happens.

Once you write inventory down at year-end, the lower amount becomes its new cost. Under U.S. GAAP (ASC 330-10-35-14), you do not write it back up if prices recover later. For interim reporting, ASC 270-10-45-6(c) requires a recovery of a previously recognized loss on the same inventory in a later interim period of the same fiscal year to be recognized as a gain. The gain is limited to the loss previously recognized on that inventory.

A few industries, such as certain agricultural commodities, can carry inventory at NRV even when it exceeds cost. See inventory at net realizable value: when can it exceed cost?

Worked example: a lamp that sells above cost

Suppose Alder Light has 80 identical desk lamps at year-end. Each lamp has accumulated $60 of cost. A buyer will pay $68 per finished lamp. Alder still needs to spend $6 on assembly, pay a $3 sales commission, and cover $4 of outbound shipping per lamp. Each of those costs is separate.

The customer’s $68 covers the $60 already spent, with $8 to spare. Finishing and delivering the lamp will consume $13. That leaves a $5 shortfall on every lamp. Alder reports inventory of $4,400 and recognizes a $400 loss at year-end. The lamps are still physically on the shelf.

Journal entry for the lamp write-down

At year-end, Alder records:

Debit: Loss on inventory write-down (or Cost of goods sold) $400
Credit: Inventory $400

Many companies include routine write-downs in cost of goods sold. A large or unusual write-down is often shown on its own line so readers of the financial statements can spot it. For the full entry and how it affects gross profit later, see our inventory write-down journal entry lesson.

Which costs belong in the estimate?

Use costs the seller still expects to incur to complete or dispose of these goods. If the original $60 already includes inbound freight, deducting it again from the selling price counts the same expenditure twice. If the customer will pay the carrier directly and Alder owes nothing for shipping, remove the $4 from Alder’s estimate. NRV then rises to $59 and the write-down falls to $1 per lamp.

An exam question may provide replacement cost or a normal profit percentage. Neither is an input to this NRV formula. First identify the applicable rule. If the problem gives several products, also determine whether to compare cost and NRV by item, category, or total. That choice determines which figures you compare before you record the inventory write-down.

LCNRV vs lower of cost or market (LCM)

LCM still applies to LIFO and retail method inventory. Under LCM, “market” means current replacement cost, which is what it would cost to buy or make the item today. Two limits apply. Market cannot be higher than NRV (the ceiling) or lower than NRV minus a normal profit margin (the floor).

Here is the lamp under LCM. Assume replacement cost is $57 and Alder’s normal profit is 10% of the $68 selling price, or $6.80.

• Ceiling (NRV): $55
• Floor (NRV minus normal profit): $55 − $6.80 = $48.20
• Replacement cost: $57, which is above the ceiling, so market is $55
• Lower of cost ($60) or market ($55): $55

Both tests give $55 here, but they will not always agree. If replacement cost had been $50, it would sit between the floor and the ceiling, so market would be $50. LCM would report $50, while LCNRV would still report $55.

Exam tip: if a question gives you replacement cost or a normal profit margin, check which rule applies before you use those numbers. Under LCNRV, ignore them.

Key takeaways

• Under the general U.S. GAAP inventory measurement rules, LCNRV applies to inventory measured using methods other than LIFO or the retail method, which use LCM. Industry-specific measurement exceptions may apply.
• NRV = expected selling price − costs to complete − costs to sell and ship that the seller pays.
• Report the lower of cost or NRV, and record any shortfall as a loss in the period the decline occurs.
• Under U.S. GAAP, a year-end write-down becomes the new cost and is never reversed.
• Replacement cost and normal profit margin belong to LCM, not to the NRV formula.

Interactive LCNRV practice quiz

Use the lesson above to test how well you can calculate net realizable value, choose the inventory carrying amount, and determine when to recognize a write-down.

Practice questions and answers

Which amount belongs on the balance sheet?

A finished item costs $47, will sell for $51, and requires a $6 selling commission. NRV is $45 ($51 − $6). Report $45 and recognize a $2 decline. The $2 is the expense, while $45 is the remaining asset.

Does a markdown always create a loss?

A $110 item marked down from $160 to $130 requires $8 of selling costs. NRV is $122, which still covers cost. The item stays at $110. The expected margin shrank, but the company can still recover its recorded investment.

Can the buyer’s delivery charge reduce the seller’s NRV?

No. A seller expects $90 for a finished item and owes a $4 commission. The buyer separately hires and pays the carrier $7, so that charge never comes out of the seller’s proceeds. NRV is $86 ($90 − $4). Only costs the seller pays reduce the seller’s NRV.

Frequently asked questions

How do I distinguish NRV from ending inventory?

NRV is an estimate calculated from selling price and remaining costs. Ending inventory is the amount selected after comparing that estimate with recorded cost. The two are equal when NRV is the lower figure.

When does the business recognize a decline?

Recognize the loss in the period in which the decline occurs. Waiting for a later sale would leave the inventory asset too high at the current reporting date.

Can an inventory write-down be reversed?

Not under U.S. GAAP once the fiscal year closes. The written-down amount becomes the new cost, even if prices recover. IFRS (International Financial Reporting Standards) is different: IAS 2 allows a reversal, limited to the amount originally written down.

Is lower of cost or net realizable value the same as lower of cost or market?

No. LCM compares cost with replacement cost, limited by a ceiling (NRV) and a floor (NRV minus a normal profit margin). LCNRV compares cost with NRV only. LCM now applies only to LIFO and retail method inventory.

Does IFRS use the lower of cost or net realizable value rule?

Yes. IAS 2 generally measures inventories at the lower of cost and net realizable value. Its measurement exceptions include qualifying inventories held by producers of agricultural and forest products and minerals, and inventories held by commodity broker-traders measured at fair value less costs to sell. LIFO is not permitted under IFRS.

Where does an inventory write-down appear on the income statement?

Most companies include it in cost of goods sold. When a write-down is large or unusual, companies often show it as a separate line or explain it in the notes.

Want more practice like this? Start with the Farhat Lectures free sample course, then work through the full inventory unit in the Intermediate Accounting course.